Some of you may hold mutual funds, or may be considering buying mutual funds in your financial portfolio. They are certainly a viable solution to building wealth over the long term. Some of the reasons why you would consider buying mutual funds might include the following:
- You have very little financial knowledge and your financial advisor recommended you buy mutual funds
- You think professional money managers are smarter and better off picking stocks for you, so you let them manage it
Well hopefully you’re reading this blog to educate yourself and make the proper choice rather than blindly listening to your financial advisor. If number two applies to you, then perhaps you might want to rethink your strategy. It’s true that some risk is taken away when you have money managers working for you to pick stocks, but despite the fact that they are professionals in the financial field, this does not make them an all-star stock picker by any means.
When buying mutual funds, one of the methods that fund managers want to perceive “value” to their shareholders is to make it look like they are working hard for them. This means they will constantly be trying to find stocks that are winners and buy and sell the fund’s portfolio to keep “chasing” winners. This effect of buying and selling has an adverse impact on the return you get from the mutual fund.
Imagine if you were trading stocks and bonds for yourself. If you kept switching what you held on a regular basis then your commission charges would add up. You would also end up paying capital gain taxes on any profits you made from the stock or bond that you sold. A mutual fund is no different. It is subject to the same commissions and taxes that you would get charged if you had invested as an individual. These expenses add up over time, as more and more transactions are completed. Not only that, but when you receive distributions from the mutual fund at the end of the year, or whenever distributions are given, you will be subjected to the capital gains taxes that were created by the manager that was buying and selling shares. That’s a double whammy. The value of your mutual funds are stripped of its assets through commission fees and you are paying more taxes when you file income taxes in April.
What you need to look out for are mutual funds that have a high turnover percentage. If you own mutual funds right now, go check out Morningstar and see how high the turnover percentage is. If you see that the number is almost 100% then it means that in any given year, all the holdings in the mutual fund are bought and sold. Think of it this way. At the beginning of the year you start with all the clothes and pants in your closet. During the course of the year you end up replacing every single shirt and pants in that closet so that you now have a brand new wardrobe. You keep repeating this every year. Think of all the money that you just spent. Imagine that for your mutual fund. Think of all the wasted money that was paid to commissions just to make it look like your mutual fund manager was working hard for you.
So it seems that mutual funds are not so great after all. You might be wondering why you should buy mutual funds at all. Should you stick to just GICs and not let the bankers take your money? As I stated previously, not all mutual funds are made alike. Some will have low fees, low turnover and good performance. It all depends on what mutual fund you buy. Just don’t get suckered by your financial advisor in buying funds that he or she recommends. Do a bit of research. Take suggestions and recommendations from your advisor and then research yourself on Morningstar to see if it’s even a good mutual fund to own. When it comes to your money, it pays, literally, to do a little bit of due diligence on your part. Don’t be naive and just follow someone else’s advice.