This is going to be so much fun!
Very few times here do we get to simply tee off on the industry.
And fortunately for you, this is one of those times.
In our latest comparison battle, we will look at mutual funds vs stocks…and boy are we THRILLED to do so. The Wall Street boilerplate of gathering assets and charging fees vs pushing the button yourself. Gee…I wonder who we think it going to come out ahead here???
I need to stretch out my fingers before I write the rest of this. Not because I’m going to write a book or anything but just the sheer force that I will be banging on the keyboard when I write the rest of this article with a lot of force, thus I don’t want to injure myself.
The way to think of mutual funds is as follows. A bunch of different financial advisors take their client’s money and give that money to someone else to manage. Well Jesus, that sentence right there should be enough for you to run the other way if a financial advisor ever suggests investing in a mutual fund through him/her. That new manager invests the funds however he/she deems fit which could be a combination of stock, bonds, commodities, etc. The individual who handed over the money in the first place owns a percentage of the fund in accordance with the size they invested vs the overall assets under management.
Investing in these mutual funds can bring profits to the individual in the more of interest, dividends, appreciation, etc. A key selling point for these funds is their ability to automatically re-invest those profits right back into the fund. Duh…
I knew my last sentence was familiar. Keep them coming back for more. Take the clients money and put it right back into your pocket.
Mutual funds have a few selling points that they use to gather your assets and charge you fees. I feel like we could stop here because the battle of mutual funds vs stocks should be over by now. But I am feeling alerts so I am going to power through and keep cranking. Right, so I was talking about the “value props” and “selling points” for these mutual funds.
Before getting into these, a simple Google search for the top mutual funds will land you on our friend Vanguard and specifically the Vanguard Value Index Fund Investor Shares ($VIVAX). From their mouths:
This fund invests in stocks of large U.S. companies in market sectors that tend to grow at a slower pace than the broad market; these stocks may be temporarily undervalued by investors. This low-cost index fund follows a buy-and-hold approach, and invests in substantially all of the stocks contained within its broad benchmark. In addition to general stock market volatility, the fund’s primary risk comes from the fact that at times its focus on large-capitalization value stocks may underperform the broader stock market.
Bore me. On top of whatever that means, here are a few of the selling points mutual funds use to win the battle of mutual funds vs stocks and your money.
Hey. You don’t have 10 minutes a day to look at the market. So give me your money! Oh and yes…I am and PROFESSIONAL and I have been doing this for 30 years. And where hedge funds require a lot more capital to become invested in their funds, mutual funds allow smaller investors to have to ability to have their money managed by the seasoned vets.
For starters, the professional money management industry has underperformed the benchmark for the 4th year in a row and 2016 saw 35% more funds dissolve than form. Not great. Do you really think those professional money managers know more than you? Or anyone for that matter? No, they do not!
The diversification pitch has been around since the beginning of Wall Street. Own a big basket of stocks…stocks and bonds…spread out risk…diversification…blah blah blah. We have all heard it here before and it is such a crock. The selling point for diversification as a risk minimizer is simple…spread out assets over buying and selling a large number of stocks and bonds in different sectors so that no one investment can take you down. While we always hope this to be true, these professionals do a terrible job of it. They completely forget that on down days…stock have double the correlation that they do on up days. Yes…that’s right. Stocks are far more diversified on down days.
Let’s use the latest Vanguard example to see how diversified these funds really are and how smart these money managers really are. Mutual funds vs stocks is going to start getting very one sided I sense.
Let’s see how diversified this mutual fund who uses diversification as a selling point really is.
In order to do this, we need to compare price movements of each of these stocks over the last year. If two stocks both move up 1%, we see that as 100 correlation. This would be high correlation. If one stock moves up 1% and another down 1%, we see that as -100 correlation. This would be negative correlation. If one stock goes up 1% and another does not move, we see that as 0 correlation. This would be no correlation. Make sense? Good.
The above chart shows the correlation for the top 10 holding of this Vanguard mutual fund. If a cell were to be red, there would be negative correlation. We do not see any of those. If the cell were to be white, there would be little correlation. We see 12 out of the 100 possible cells white. All other cells (82) have some levels of correlation to one another. The darker the green, the higher the correlation. I don’t know about you…but unless you are color blind I see a ton of green and dark green cells here. I would have to say that the top 10 holdings in this mutual fund are pretty correlated to one another. This would mean these holdings are not diversified.
The pitch here is…because the fund has so much money in it, their transaction costs are so much lower than you are I could get. This is pretty true. At the same time, there is so much liquidity in the fund that you can get in and out whenever you want.
Cough cough. Have you ever noticed that when you buy or sell into our out of the mutual fund, they only tell you the price the mutual fund was when the transaction was made? Why don’t they show the price of the stock that they traded? Here is a fun one. Have you ever guessed why it is so easy for mutual funds to have such small management fees and expense ratios? How do all of these managers make money? We know that the offer is what someone is willing to sell for and the bid is what someone is willing to buy for. Mutual funds get kickbacks from other institutions as well as the financial advisors get kick backs from the mutual funds because they do not deal with the bid or the ask that you and I do. This is how they make money…
Hey, Mr. Institution selling 100,000 of Apple. The offer right now is $125.30 but in order to fill me at this full amount and because I need a way to make money when my fund’s expense ratio is so small, I am going to buy those 100,000 shares from you at $125.42. To the individual, this is a few cents, but to the manager getting the commission, they just pocketed $1200. Do we even need to go on with this mutual funds vs stocks battle anymore?
In the battle of mutual funds vs stocks…do taxes matter? Do they add up to anything? Mutual fund advisors will tell you there are tax benefits to investing in them.
They do not. Mutual funds can hold stocks for over a year in order to achieve long-term capitals gains just as easily as anyone with a laptop. Mutual funds can also put that money into and IRA or 401k to have the money grow tax-free just as easily as anyone else can too.
Mutual Funds vs Stocks…What are the Excuses?
Now I get what you are saying…
But I don’t have time to worry about stocks. I can just give my money to Vanguard and they can do it for me. I don’t have to look or worry about it.
Well for starters, when you read Yahoo Finance and see the market is falling, you will care about it.
And second, don’t look me in the eye and tell me you don’t have 5 minutes every week to look at the market.
In life, if we just kinda want things, we just kinda get results. If we really want things. We really get results.
And don’t bother giving me that speech about how mutual funds outperform the market…because according to Vanguard…they do not.
Mutual Funds vs Stocks…What to Do?
In my opinion, in the question of mutual funds vs stocks…stocks are the clear winner. There is too much behind the curtain for my taste with mutual funds. You don’t know where you are getting nickeled and dimed and again, the goal of Wall Street is to gather your assets and charge you fees.