Chapter 32. Lessons to Remember

Mutual funds form a prominent part of many individuals' entire investing program. The growth of mutual fund assets in recent years is extraordinary, which means that investors have voted with their checkbooks. For many of us, over most of our investing life, investing either for retirement purposes or for wealth-enhancement purposes in taxable accounts means a major commitment to mutual funds.

Mutual funds have worked well for many investors for a long period of time. If success can be judged by dollars invested, mutual funds, with assets of approximately $7 trillion, must be judged successful. If success can be judged by the percentage of total mutual fund assets owned by households, mutual funds must be judged successful because this percentage rose from 76 in 1990 to 80 in 2000. If success can be judged by the percentage of U.S. households owning mutual funds, mutual funds must be judged successful because this percentage went from about six in 1980 to 52 by the end of 2001.

Mutual funds have, to a significant extent, served investors well over the years. They provide instant diversification, which is a mandatory requirement for all intelligent investors. Recent research suggests that even more stocks are required for adequate diversification than was thought to be the case for many years, and the purchase of mutual funds is an easy way to achieve this objective.

Investors can choose from a range of objectives with mutual funds. They relieve investors of the decision-making responsibility involved in the ongoing investing process and they offer conveniences such as check-writing, automatic reinvestment, automatic periodic investing by deducting a specified amount from a checking account, and so forth. Mutual funds serve the public well by offering a variety of useful features.

Yet more and more investors have come to realize that everything about mutual funds is not ideal. They are now reading some articles in the popular press that are critical of mutual funds. Furthermore, many investors have experienced firsthand some painful observations about mutual funds when it comes to taxable distributions ”they had significant tax bills for the year 2000 as a result of distributions from their mutual funds at the same time the prices of these funds were declining sharply.

Many investors have gotten on the merry-go-round of chasing performance, only to see it coming crashing down sooner or later. The technology bust in 2000 is but one example, but it is a doozy. Technology funds soared in performance, investor money came pouring in, and the crash occurred. In one 12-month period ending in March 2001, the average technology fund lost about 62 percent of its value. Something like this gets virtually everyone's attention.

Meanwhile, the game goes on. Every day, week, and month, the popular press continues to feed the frenzy with new articles on the best funds to own, the funds that every investor should buy now, and so forth. It is a house of cards, built on past performance that was good ”but such performance typically does not continue.

Consider fund advertising. Some $500 million was spent by mutual funds to advertise in 2000. The market suffered greatly from March 2000 onward, but fund advertising was actually up in January and February of 2001. Funds were doing their best to hold on to their shareholders. SEC regulations prevent funds from simply showing those periods when the fund did well. Instead, they must present results for one year, five years, and the life of the fund.

So what do you think funds do in their ads? Many show their best performing funds only. For example, bond funds may be performing well when stock funds are not. Some sector funds will be performing well while others are not ”guess which ones are likely to be featured in current advertisements.

Meanwhile, more and more funds were created as companies tried to achieve the big performer that would pay off very well. Since 1970, the number of funds has declined in only one year, 1975, and this by a grand total of five. It is noteworthy that 1973 and 1974 saw a sharp decline in the market, with two years of large losses.

Investors are becoming more aware of the costs of mutual funds. Distribution costs such as the 12b-1 fee have been piled on in recent years. Different share classes confuse investors and compound their problems as they attempt to determine which class of shares they should own. Even worse , they really don't understand the different classes of shares at the outset and therefore never make a good purchase decision to start with.

The fund companies attempt to grow larger and larger because much of their reward is calculated as a percentage of assets under management. During the great bull market of the late 1990s, when investors were euphoric over the high market returns, many did not notice, or object to, the increase in fees assessed by the companies. The good times were rolling, so why rock the boat?

As noted, investors got a very rude shock for the 2000 tax year when mutual funds made the largest capital gains distributions in history. Investors had no control over these distributions because the fund companies were required by law to make them, based on the great gains scored in 1999 and earlier years. So, regardless of their own tax situation, in rolled the big distributions. In the face of that, the market went down, fund values declined, and the typical mutual fund shareholder had a loss on the investment for the year.

With the negatives becoming more and more apparent, mutual funds are starting to lose some of their appeal . Investors are asking, "Do I really want to continue to subject myself to these types of issues? If not, what can I do about it?" At the very least, shareholders might begin to demand more from their funds in terms of being better served and more fairly treated. If they are fully aware of the issues, they might be more ready to move their money to those funds that will better represent their interests.

Until recently, investors (or at least those without assets in the millions of dollars) did not have many good alternatives to mutual funds. Many investors knew they should own common stocks for the long run, because stocks have the highest returns over time. Logically, for a variety of reasons, many investors chose funds as the way to own stocks. Mutual funds were, in many ways, the only practical game in town.

This is no longer true. Investors now have alternatives available that are becoming better known. An alternative such as ETFs currently has at least a short track record, is being widely discussed, and is becoming better understood . Like the other alternatives currently available, it offers some advantages over mutual funds. ETFs are continuously traded during the day, can be sold short, or bought on margin. Taxable distributions are typically few.

Folios are only now starting to be noticed, but could grow quickly. They offer convenience through the Internet, and flexibility in terms of constructing a portfolio more to the investor's liking. Costs are low, and the minimum investment is either nothing or a low number such as $5,000.

Managed accounts are also catching on with investors. The assets in these accounts, although still small by mutual fund standards, have been growing rapidly . These accounts can be obtained through the Internet, through brokers , or, increasingly, through fund companies. They offer some professional management coupled with a tailored approach to a particular client's needs. The tax flexibility can be of enormous appeal.

Investors must ask hard questions about their portfolio assets, particularly the mutual funds they hold. Do they really understand what the mutual fund they own is doing, and why they are holding it? Are they fully aware of the class of shares they own? Are they fully aware of the total costs imposed on them by the fund? If the funds are held in taxable accounts, are they prepared for the tax consequences when big distributions occur?

It was true in the past, and it still is to a significant extent, that the easy way out when it comes to investing is mutual funds. You write a check, buy into one or more mutual funds, and let the investment company manage the portfolio and take care of the paperwork and other issues. This remains a viable and sound alternative because the most important thing you can do for yourself is to invest in a sensible manner using a legitimate , sound outlet. You build wealth for the future by saving, investing, and letting your money compound over time.

Certainly, mutual funds facilitate the wealth-building process. But just as surely, they are not necessarily the right asset for all investors, all of the time. You owe it to yourself to carefully consider all of your alternatives. After all, it is your money and your choice.



Mutual Funds(c) Your Money, Your Choice... Take Control Now and Build Wealth Wisely 2002
Mutual Funds(c) Your Money, Your Choice... Take Control Now and Build Wealth Wisely 2002
ISBN: N/A
EAN: N/A
Year: 2004
Pages: 94

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