4 Dangers of Mutual Funds and Why Some Investors Avoid Them
Mutual funds have long been touted as a safe and reliable investment option for individual investors. These pools of money, managed by professional fund managers, allow investors to gain exposure to a diversified portfolio of stocks, bonds, and other securities with a relatively small amount of money. However, in recent years, more and more investors have begun to question the value of mutual funds, and there is growing evidence that these investment vehicles may not be as safe or as profitable as they once were.
- One of the main reasons investors are turning away from mutual funds is the high fees that they charge. According to data from the Investment Company Institute, the average expense ratio for mutual funds was 0.61% in 2019, which means that for every $100 invested, investors paid $0.61 in fees. While this may not seem like a lot, over time these fees can add up, eating into the returns of the fund. In fact, a study by Morningstar found that high fees were the single largest predictor of poor performance in mutual funds, and that over a 30 year period, a 1% difference in expense ratio can result in a 28% difference in total return for the investors.
- Another problem with mutual funds is their lack of transparency. Often, the fund managers are buying and selling stocks without disclosing their moves to the investors, so investors have no idea what the managers are doing with their money. Additionally, a lot of mutual funds are not actively managed. Instead, they are simply following a benchmark index like the S&P 500, which means that investors are essentially buying an index fund with higher fees.
- This next concern is major, yet rarely considered: mutual fund managers often do not invest in their own funds. A study by the Wall Street Journal found that only 14% of mutual fund managers invested more than $10,000 of their own money in their funds. This lack of "skin in the game" raises questions about the managers' level of commitment to the fund's success and can further erode investor confidence.
- Lastly, It’s also worth noting that mutual funds tend to underperform their benchmark index over the long term. According to data from S&P Dow Jones Indices, only 24% of actively managed mutual funds were able to beat the S&P 500 over the 10-year period ending December 2019. This means that the majority of mutual funds failed to provide better returns than a simple, low-cost index fund.
Given all of these concerning issues, it seems clear that mutual funds may not be the safe and profitable investment vehicles they once were touted as. While they may be suitable for some investors, particularly those who are looking for a diversified portfolio of stocks and bonds, they are not without their flaws. High fees, lack of transparency, mutual fund managers not invested in their own funds, and the potential for poor performance are all factors that investors should consider before investing in mutual funds. For many investors, it may be better to consider other investment options, such as index funds or exchange-traded funds, which have lower fees and a more transparent investment process.