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These Mutual Fund Lies Could Destroy Your Retirement

By John Persinos on December 20, 2016

Gordon Gekko, the villainous trader you love to hate in the movie Wall Street, put it best: “Sheep get slaughtered.”

If you’re worried about your investments in what promises to be a volatile 2017, just remember that passive, sheep-like investors who put their portfolios on automatic pilot will get hurt the worst.

No matter what your investment goals or time horizon, you should always apply your own rational analysis when it comes to your savings.

It’s difficult for humans to avoid the herd mentality. After all, they’re social animals and as such, take their behavioral cues from others.

This herd-like tendency is glaringly apparent when it comes to mutual fund investing.

Let’s face it: the mutual fund, by its nature, attracts investors who like to delegate analysis to others.

Mutual fund investors often believe the myth that they can just leave everything to the fund managers. I can’t really blame these fund managers for perpetuating lies about their investment infallibility, but I can blame you for believing them. These fallacies are ruinous to your wealth creation.

The wolves of Wall Street…

No one could accuse our in-house investment team of being “sheep.” I asked them to put together a list of the most common misconceptions about mutual funds, as well as a checklist for assessing and picking the mutual funds that are right for you. I culled their best answers; you’ll find them below.

As you analyze the multitude of mutual fund alternatives, don’t fall for what may be the four most prevalent mutual fund fictions:

1) Because they’re diversified, mutual funds entail little risk.

As with all securities, mutual funds are subject to market risk. No matter how highly you think of the fund management’s expertise and track record, there is no way to predict the future or whether a given asset will rise or fall in value.

2) Mutual funds are always long-term investments, suitable for retirement. Invest in them and forget them, until you need the money.

False! Many fund managers run their respective funds with short-term “beat my benchmark” performance goals in mind. If you don’t regularly monitor your fund and change course when warranted, you could be left with a poor investment.

3) As fund assets increase, mutual fund costs will decline.

For most funds, this has yet to occur. As they’ve grown bigger, many funds continue charging higher fees.

The investment industry continually pushes the lie that the statistical law of large volumes, when applied to mutual funds, will protect the average individual investor from paying too much. The theory says as a fund’s assets expand, each individual becomes responsible for a shrinking percentage of the fund’s fixed costs.

In reality, expenses for many funds have followed only one direction: UP.

4) Taken as a whole, mutual fund returns meet the expectations of investors.

Not true. Indeed, a majority of funds don’t even reach their benchmark index.

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Mutual Fund Reality Checks

When looking at mutual funds, apply these four “reality checks” to ensure you understand what you’re getting into. Here are some of the fund characteristics you should scrutinize:

1) The fund manager’s investment strategy and whether or not it is relevant to your investment needs.

The fund manager’s investment strategy can be found in the fund’s prospectus, usually on one of the first few pages. Make sure it’s a strategy that you agree with and that serves your needs.

For example, if you’re invested in a mutual fund for your retirement, the fund should be conservative and suitable for long-term investors.

2) The fund’s expense ratio, also stated in the fund prospectus.

The fund’s expense ratio is its annual operating expenses divided by its average annual net assets. An expense ratio is the percentage of your assets a fund claws back each year as payment for its services. Most analysts consider an expense ratio of 1% or less to be reasonable.

3) Fund performance over three different time periods: the past year, past five years, and since inception.

A manager might get lucky over a short time frame, but if you use longer yardsticks you’ll be able to separate true talent from sheer luck.

4) Portfolio turnover, as stated in the prospectus.

Keep a special eye out for unnecessary turnover within the fund.

According to industry analysts, in recent years fund managers have racked up an all-fund average turnover of about 85%.

In fact, many funds have turnover ratios in excess of 100%. In other words, in the aggregate, managers sold all the shares that they owned at the beginning of the year and bought new ones.

This sort of intense trading exposes you to the twin enemies of investing profits: income taxes and trading expenses. Industry experts estimate that trading expenses sock investors for between 0.7% and 2.0% every year, and income taxes can eat up another 0.7% to 2.7%, depending on your particular tax bracket. Add up all of these hidden costs, and they can take a big bite from your potential gains.

According to some estimates, hidden expenses altogether generate an estimated all-in cost of 4.52% for a taxable investor or 3.52% for non-taxable accounts.

Take care to screen all funds for unreasonable turnover ratios. If you pinpoint a fund that sports a turnover rate of 50% or more, calculate whether its returns are higher than funds with lower turnover rates.

Keep in mind the time periods involved and whether these returns were consistent. If you take the time to look, you can find plenty of low turnover funds that won’t rack up unnecessary costs and fees by “churning and burning” your holdings.

Got any mutual fund questions? Email me at: mailbag@investingdaily.com. — John Persinos


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