There has been much debate over the past decade about the value proposition of actively-managed mutual funds to the average investor. The potential advantage which you’re really paying for with mutual funds is the possibility of choosing a brilliant portfolio manager who can beat their benchmark year after year. I’ll only break out one statistic here among the many which convey the same unfortunate message about the mutual fund industry: six out of ten actively managed stock funds underperformed their indices in 2008, primarily due to fees, according to the Center for Institutional Investment Management at the University of Albany. Besides the fact that actively managed mutual funds, on average, cost investors more to own than index and exchange-traded funds, they are also generally less transparent than index and exchange-traded funds. This isn’t necessarily a criticism of mutual funds, but an inherent operational difference between two very different investment products: mutual funds and exchange-traded funds.
At the time when mutual funds really gained in popularity (the 80’s) the stock market seemed to only move up. Having a nice diversified basket of securities with an active manager was a fine idea. The past ten years have taught us many lessons about the volatility inherent in stock and bond investing and have alienated plenty of 1980’s and 1990’s investors who can’t take the constant fluctuation. So what should you do?
Unfortunately, retirement plans such as 401ks and 403bs usually only allow investors access to actively managed mutual funds. Some offer access to index funds and rarely an exchange-traded fund will make its way onto the menu. Some critics of the mutual fund industry, such as pension expert Matthew Hutcheson have done studies highlighting the long-term potential damage to retirement plan investors caused by excessive costs, hidden fees and an overall lack of industry accountability.*
The Hutcheson paper referenced above also itemizes the different sorts of expenses which are paid by the investor from mutual fund expense ratios. I found, and I’m sure many investors would agree, many of these costs are onerous and burdensome.
My point is basically that many investors have incomplete information about the mutual fund industry. The opinion which has been surfacing more and more lately in financial journals is that investors should pay attention to what they can control—namely fees and expenses within their investment portfolios. In my opinion, one way to do that is through less exposure to actively managed funds and more exposure to cheaper and cleaner portfolios using individual stocks, bonds, and index-style investments.
Investing in mutual funds involves risk, including possible loss of principle.
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*Matthew D. Hutcheson, MS, CPC, AIFA, CRC — Uncovering and Understanding Hidden Fees in Qualified Retirement Plans: University of Illinois Elder Law Journal: Fall 2007