Mutual Funds Are Good For Mutual Funds

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The latest Kiyosaki column on Yahoo Finance is about how mutual funds are a bad deal because the fees are just downright nasty. The bulk of the article is an excerpt from an interview with John Bogle, founder of the Vanguard Group, on Frontline where he reveals that mutual funds are a raw deal. Usually when I read a Kiyosaki piece (or any “expert advice”), I’m looking to rip it to shreds because that’s the way you should approach all “expert advice” until you have enough personal trust in that writer to take the quotes off. In this case, Kiyosaki is spot on, traditional mutual funds are a rip-off and Bogle gives him good ammunition as to why.

Essentially, if you get an 8% return for 65 years and put in a mere $1,000 at the start, it will be worth $140,000 at the end. Now take away 2.5%, typical management fee for a mutual fund, every year and you go from $140,000 at the end of the year to a mere $30,000 – somewhere in that mathematical chicanery 80% of the difference is lost to the financial system. Skip to the end if you want to find out where it went. So you put up 100% of the capital, assumed 100% of the risk, and earned a little over 21% of the potential return.

Kiyosaki does make some good additional points… specifically “The next time you hear a financial expert recommend that you ‘invest for the long term in mutual funds,’ take a moment to ask them to explain how their fees work over the long run.” You should always be asking how the fees work whenever you talk to any professional, financial or otherwise, but it’s especially poignant to hear how someone will profit from your investments (because they will!).

The next good point, one you’ll hear often, is that you should invest in index funds if you’re going to go the fund route. Smaller fees mean more bang for your buck and when 80% of mutual funds typically won’t beat the market, it’s doubly better for you.

So where does the money go? Who makes it?
Actually no one in the financial system does (if the brokerage doesn’t invest the fee money in its own mutual fund), it’s as if you took that 2.5% out every year and spent it on a toy elsewhere. Actually, it’s more like if your neighbor took 2.5% out of your portfolio and spent it on his toy elsewhere.

{ 17 comments, please add your thoughts now! }

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17 Responses to “Mutual Funds Are Good For Mutual Funds”

  1. Kira says:

    80% is lost, but it doesn’t go into the fund’s pockets – that’s the result of the money from the fees not being there to be compounded. He’s using a lot of hyperbole and very little math.

    And yes, you put up all the capital and took all the risk, but you couldn’t have made a portfolio like that on your own without paying that much or more in trading fees. Not to mention that you can buy $50 worth of mutual funds and get instant diversification, whereas $50 might not even buy you one share of stock in many companies.

  2. John says:

    Say your 401k has only 1 index fund. It’s based on the S&P 500. Should you just lump all of your money into that one fund, or should you put most of it in the index and a little into a bond fund with annual operating expenses around 0.6%? Seems that a couple of different types of investments would be a good idea…

  3. Hazzard says:

    I think the key is to choose a few different index funds from different sectors. I’ve got some large cap (S&P) funds, small cap index fund, and an international index fund. All of them have very low fees compared with actively managed funds. I’ve also seen much better returns in my small cap and international funds. When those start performing worse, I’m hoping the S&P will pick up some slack.

  4. LAMoneyGuy says:

    Kira is right on the money, Kiyosaki’s “math” is atrocious. Do the math yourself, and you will find that the fund company in his example makes about $14k total over the 65 year life of the fund.

    2.5% is rather high. Most actively managed funds have expense ratios more like 1.5%. Also, 80% of funds failed to beat the S&P in the 80s and 90s, a period of generally increasing prices. It is extremely difficult to outguess the market in a period of rising prices. During a period of flat or generally downward prices, you are better off with a good manager. Emphasis on a GOOD manager.

    Kiyosaki always has something thought provoking and a great point somewhere in his junk. But his junk is so hard to take. In this case, it’s the excruciating math.

    Also, the “100% of the risk” schtick is no good. The SEC disallows profit sharing arrangements, except for in the case of “accredited investors” or investors with 200k+ income, or 1mil+ investable net worth. Yes, the investor takes 100% of the risk. But a client of a criminal defense attorney takes 100% of the risk of going to prison. A client of a tax accountant takes 100% of the risk of overpaying, or getting fined for incorrect returns. A client of a doctor takes 100% of the risk of dying.

  5. CK says:

    What expert advice this is. Essentially don’t buy a mutual fund with high fees. Oh really thanks for the tip.

  6. Investorial says:

    I always think it’s good to stir up the conversation. Moomin Valley is against Kiyosaki’s position on this issue. Who’s right?

    Perhaps a better question is “Is it even about right or wrong?”. I like having many perspectives!

  7. moominoid says:

    All reported mutual fund returns are always after fees. So there is no problem in comparing the returns of mutual funds with different fee percentages. That’s why I say the fees don’t really matter. The question is: Are they earning their keep? Sometimes yes and sometimes no.

  8. Jason says:

    I dunno, I didn’t get the impression that I was getting an honest or unbiased evaluation when reading that article. That said, it seems pretty easy to me. Do you believe that mutual fund manager will beat the market by more than its expense ratio and fees? If it does than the actively managed fund is definately worth it. However, since most funds don’t beat the market its kinda hard to justify using them over index funds in alot of situations. I think personally as I learn more and become more experienced I will use index funds unless I come across some very low expense mutual funds.

  9. Kira says:

    The problem that I have with much of Kiyosaki’s stuff is that he seems to think that people want to spend their lives managing and making money. Half the reason that you have a mutual fund (even more so with a lifecycle fund or something like that) is that you want to buy it and forget about it. He is very into real estate, which yes that can make you money, but landlording is not a fun life and it will take up all your time. He is also into commodities and precious metals and other things that are usually too complicated for the average person to follow. It is not worth risking your money on things you hardly know anything about! For a lot of people, even 2.5% fees is better than letting your money sit in a savings account because you don’t know what to do with it, or losing your mind trying to manage rental properties if you don’t have the temperament.

  10. Dus10 says:

    I have to say, this seems quite odd. I just met the the plan advisor for my company’s 401(k). Since my eligibility begins Saturday, I am ready to dive into this great plan… but it is not so great. The match is totally awesome, though. They match dollar-for-dollar on the first 3%, and 50-cents-to-the-dollar on the next 2%. This is all vested 100% on day one. Then, there is a profit sharing aspect that they contribute 8% of my pay throughout the year, and a discretionary 2% at the end of the year. That is vested 100% after two years. That means a total of 19% of my income per year. However, the plan is through Lord Abbett, and I am not that familiar with them. I do not know if this is through the choices of my company or just what Lord Abbett provides, but there are only eight funds available, and they are only available as A-Shares with a 2% front-end load. These are retirement accounts!!! Why A-shares? If they offered B-Shares, they could phase into A-Shares and have no load. There are pros and cons either way, but we have no options. But, I am not passing up the extra 14% bump in my pay, either.

  11. Tony says:

    I thought Jason’s comment really summarizes this discussion the best:

    “Do you believe that [the] mutual fund manager will beat the market by more than its expense ratio and fees? If it does than the actively managed fund is definitely worth it.”

    How many agree that it is this simple?
    The reason why I ask is this has basically been the response of my “professional” Fin. Advisor and I tend to agree with him and Jason. However, the hard part is now following whether or not your fund continues to beat the market….

  12. moominoid says:

    At a basic level it is that simple. But as I said the evidence is that the different sorts of funds perform differently in different sorts of market conditions. How about a balanced portfolio of both with periodic rebalancing if you really aren’t sure?

  13. moominoid says:

    A point that just came to mind are that the fees you don’t want to pay are those mutual fund loads. These fees go back to the broker or if you buy direct the mutal fund keeps them. In Aus I use Commonwealth Securities who refund all the load/application fee on all the funds they sell (they still get a trailing fee). I guess if it is an amazing fund and there is no way to avoid the load… but often there is a way to do so, or get a discount. Again, if you have a financial manager who really deserves the fee… but if you know what fund you want try to avoid it.

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  15. GaryP says:

    Well, I could not get past the first couple of paragraphs of his article. He states: “The problem with funds is fees. The longer you invest in a mutual fund, the more you pay in fees.” But the same thing happens in his real estate investments. He has expenses, every month he has expenses! If he has some management company taking care of his property then it is costing him about 10% of his income. If he is doing it himself (yea, right) then he has the cost of his time. Plus the cost of materials, etc.!

    Just like his books, I think he just makes a lot of this stuff up. I am beginning to think he really has no clue. I mean, subtracting management expenses from return??? Maybe he learned that in a real estate book he read, but not from anything about mutual funds.

  16. LocalHero says:

    It is a known fact that fund managers do not (on average) outperform the market. Infact with fund managers all investing in the same market it is logical that half will get above average returns and half will be below average.

    The main service a managed fund can provide is a reduction in risk. They do this through diversification (through holding a large portfolio of stocks) or by investing in a lower risk portfolio of stocks (but consequently for a lower expected return).

    For the privilege of investing with them you pay a management fee. No matter how small the fee (even 0.5% per year) it will add up over time.

    Therefore investors with a long term view are better investing directly. An investor with 100K can construct a diverse portfolio of 20 stocks that will closely replicate a market index very cheaply with discount brokers and will have no ongoing fees.

  17. Ken Kensolving says:

    Well, it’s like this. If financial planners were great investment gurus, they would not need to make a living advising others on investments.

    So they are not the “experts” they sell themselves as.

    The stock market is a casino controlled by billionaires, anyway. The average person has a better chance just saving and putting his/her funds in the bank and working as long as possible.

    Forget “planners”‘ forget Wall Street, and gear up to work until you drop dead.

    It’s the age we live in. OK?

    So let’s have a drink, then.


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