to buy shares of an already-diversifi ed portfolio. The benefi ts of wide
diversifi cation are particularly attractive to those who require some
sense of security, despite the inherent risks of investing. Are mutual
funds still a brilliant idea, or have they sacrifi ced performance for
perceived security?
While there are thousands of funds with ostensibly unique
management philosophies, the consumer’s growing need for security
has driven mutual funds to overdiversify; the more stocks they own,
the more average their results. Simple index funds (a type of mutual
fund designed to approximate market measurement indices, such as
the Dow Jones Industrial Average or the S&P 500) routinely outperform
the vast majority of actively managed stock mutual funds.
This is because index funds generally achieve similar capital appreciation
(due to the high number of stocks and correlation to the
market), but charge much lower fees than most actively managed
funds. Mutual funds usually include sales charges and high expense
ratios, including management fees, load fees, administrative costs,
distribution fees, and various operating expenses.
Thus, mutual funds exhibit some of the worst habits of untrained
individual investors, including excessive trading (average turnover
of 80 to 112 percent), crystal ball attempts at market timing, and
indifference to tax effi ciencies. But the fees generated by mutual funds
pay for a lot of marketing, and the segment keeps growing. Ironically,
many providers of mutual funds are better investments than their
funds, thanks to fee income from a consumer and 401(k) market
hungry for “safe” investments. Sadly, most mutual fund investors are
not even aware of the vast web of fees they are paying, even though
these fees must be disclosed. Like most mandated communications,
the disclosures are often incomprehensible to the layman.
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