Any strong reason to buy mutual fund?

mutual fund

Any choice for investors?

I still remember when I first came out of school, investors who wanted to invest in the stock market but were unable to actively choose stocks by themselves would be “educated” to buy mutual funds. At least in that era, stock mutual funds is the only choice for those who want to invest in the stock market, but didn’t want to (or not be able to).

Because ETFs are not popular at that time, the United States was actually the same. Although index funds and ETFs were invented in the 1970s, they were not generally accepted and still far away. (Note: In 1975, John C. Bogle copied and tracked “The Standard & Poor’s 500 Index”, was the structure that created the world’s first index fund “First Index Investment Trust”, which was later renamed to Vanguard 500).

Investors get smarter

Twenty or thirty years ago, banks and goverment offices were the same. Especially in Taiwan, when there were less than a dozen of banks, local banks were almost all state owned bank, monopolizing the channels for financial management and deposits. Liked buying or not. It’s up to you, because you have no choice.

Even now, compared with many countries, Taiwan’s financial regulations are relatively closed and highly regulated. Based on the personal experience of a British immigrant to Taiwan, the BBC made a comment on Taiwan’s banks: “It seems to be stuck in the 1980s.” At that time, the people’s concept of financial management was very conservative, and it was generally believed that wealth management professionals knew better than most people in financial management or knowledge. If you still think so, then your financial managment score are dangerouse!

Due to the deregulation of banks, there are more diversified financial management channels, and more importantly, the development of technology, so that everyone can obtain the financial management information they want fairly and without time difference, and conduct more convenient and diversified investment channels; It turns out that mutual funds are not as good as claimed.

The younger generation is more open-minded, more able to accept other financial management methods, and dare to challenge the impossible. More importantly, there are more choices and performance comparison benchmarks, and anyone can invest in financial products from any country in the world to make more profits for themselves.

Performance is everything

Pandora’s box was gradually opened, and people began to discover that mutual funds were no longer the only ones, and they did not have the ability to turn stones into gold as claimed by wealth managers or agency dealers, because people had learned from many performance of mutual funds. In the past decades of performance, we have witnessed these unbearable facts.

A consistent long-term study by several well-known financial institutions:

  • Consistent long-term research by many institutions, including Bank of America (ticker: BAC), indicates that only 25% of equity fund managers outperform the broader market.
  • According to the statistics of Morningstar Direct under Morningstar (ticker: MORN) in 2021, the performance of active US stock funds lagged the market by more than 85%.
  • The latest report from S&P Dow Jones Indices (ticker: SPGI) shows that more than 79% of active mutual fund managers will perform worse than the S&P 500 and Dow in 2021.
  • The S&P Indices Versus Active (SPIVA) scorecard, which tracks the performance of active funds, with year 2023’s data showing that 79% of fund managers will underperform U.S. stocks in 2022, up from 42% a decade ago.

John Bogle has done a lot of research himself, and also cited research from a large number of authoritative institutions and people. For example, he cited research by David Swensen, chief investment officer of the Yale University Foundation: Among the many funds like ants, only about 4% of them have outperformed after taxes and fees over the past two decades. The return rate of the market is only 0.6% higher than that of the market on average; 96% of funds underperform the market, and they lose miserably: they underperform by an average of 4.8% per year. Everyone knows that fund managers and brokerage firms have made fortunes, but few have heard of fund investors who have made fortunes.

This proves one thing: no one will make jokes about the hard-earned money they make. Long-term brainwashing is still useful, especially for carefully designed propaganda. But once the beautiful myth that wealth management companies have woven for a long time and brainwashed is pierced by the performance facts, the facts can still win the final victory!

Very hard for funds to beat the market in the long run

Over the past few decades, among thousands of funds, only Mr. Bill Miller’s fund from Legg Mason has outperformed the S&P 500 Index for fifteen consecutive years. However, the margin of outperformance was not large. Later, his fame became bigger and the new money of the fund increased, but it became more and more difficult for him to outperform. In the recent years, he has seriously underperformed the market. After all, he even retired altogether later. The very fact that Mr. Miller has become a great hero for beating the market shows that beating the market is as difficult as winning the lottery.

Fund manager’s interest is inconsistant to investors

The biggest problem with stock mutual funds is that the interests of fund managers and investors are not consistent. Fund management is a job for fund managers, but it is an investment of investors. When a fund manager is faced with having to choose one of the two, in terms of investment performance and job, no fund manager will choose the fund’s performance. This is human nature and reality.

Next time when you are tempted to invest your money in any stock fund, don’t forget to ask the whether the fund manager is betting all his net worth on this fund? If yes, fund manager is required to provide a public third-party verification certificate to prove it (this requirement is very reasonable); if not, please turn around and leave.

Buffett pointed out very early on that “the interests of fund managers and investors are not aligned” is the biggest problem for fund operators.

Holding cost is extramely

Have investors ever thought about: Most hedge funds are nonsense, the skill they have is bragging only. The management fee of a hedge fund is 2% of the fund, plus 20% of the annual performance return. In other words, even if the fund does not make money, they still get 2%. If the fund’s return was positive in that year, it would make more money, and another 20% of the positive return would be get.

Jason Zweig mentioned a series of statistics about mutual funds (also known as stock funds) in his book “The Little Book of Safe Money“:

  • From 1991 to 2004, the average return of mutual fund managers was 7.4%, but in the end only 5.9% fell into the pockets of clients!
  • John Berger pointed out that from 1984 to 2004, the average return of top stock mutual funds was 9.9%, but customers only received 6.6%!
  • The University of Indiana research pointed out: From 1998 to 2001, the average return of stock mutual funds was 5.7%, and customers only have 1.0%!

Now everyone should be able to understand why the salary of fund managers is so good? Because this is all hard-earned money contributed by investors in mutual funds. Regardless of whether the fund’s performance makes money or loses money, the fund will charge a certain percentage of the annual custody fee every year.

Moreover, when investors buy and sell funds, they also have to bear a large amount of handling fees. In the entire supply chain, there are so many people relying on this for living. No wonder investors rarely hear any negative opinions about mutual funds in the media or wealth management industry, because they all rely on this industry chain for living.

Investors buy high and sell low

In his book “The Little Book of Safe Money“, Jason Zweig also highlighted:

  • From 1973 to 2002, the average annual return of Nasdaq was 9.6%. However, from 1998 to 2000, investors poured into the overvalued market and injected funds of up to US$ 1.1 trillion. As a result, investors only earned an average of 4.3 % annualized average return.
  • Between 1926 and 2002, investor returns were 1.5%, lower than market performance. The main reason is simple, because investors incline to buy high and sell low.

Why mention this data? Because investors, especially those who invest in stock mutual funds, do not go to deep research. Usually only check the current or last year’s performance of this fund. Almost everyone will buy the best-performing fund in the most recent year. But generally speaking, the performance of funds that performed well last year will be very different the next year, or the next few years.

A year later, when the fund investors saw that the fund did not perform well, they redeemed them and withdrew one after another. They rushed to buy funds that performed better the next year, and so on. It is conceivable that long-term investment is impossible. This is a typical swing trading. It is impossible to make a lot of money with this investment method.

What investors should do is to check the longevity of this fund (it is recommended to be at least ten years, why? Please refer to my other related article Whether a successful investor can be sustained?” Let’s check it out?” ) IRR, choose the fund you want to buy carefully, and make long-term investment. I suggest you refer to my other article Investors should pay attention to the annualized rate of return (IRR), How to calculate? This is the most typical “myopia” phenomenon of investors.

Beware of survivor bias

But the stock fund industry will use some marketing tricks in their industry, but investors can hardly detect the trick, the greatest stock fund manager ever, Peter Lynch once mentioned this technique in his book. The mutual fund industry will merge funds that have not reached the desired goal of fundraising, and that have not performed well for many years, into the same company’s fund with better performance.

Especially the funds with better performance (the number of better-performed funds is small, generally speaking, it is the flagship fund in a fund company, that is, the best, and the star fund with better performance) is larger in fund size. Therefore, the performance of poorly sucked funds (of course will be very poor and the size of the fund is also small) will not have much impact on the performance of the better-performed fund.

This is also the main reason why in the market, each fund company usually has only one or two funds that sell well. Moreover, the fund industry will tell you that their fund performance is very good– of course, the bad ones are merged into the better-performing funds, leaving only one or two better funds. If the flagship fund that was used as a front door does not perform well, it will be split and merged into the company’s new rising star fund, and then a better rising star fund can be used for advertising. This is why investors only see that there are always excellent-performed funds everywhere — because poor-performed funds were always disappeared automatically.

Unspoken rules of the mutual fund industry

In my article of The advantages of retail investors“, many unspoken industry rules of institutional investors (including mutual fund companies) are listed in detail. These rules inherently restrict fund companies from making big money:

  • Discourage long-term investment
  • Regulatory restrictions
  • Forced to trade
  • Not agile
  • Less investment options

Almost each of the above limitations is a factor that prevents investment from being successful. After smart investors read these restrictions, do you still believe that investors who rely on this set of investment principles can make money for you?

Buffett’s view on mutual fund

Please check the detail I post in my previous blog article “Why do stock funds perform so poorly? How bad is it?

mutual fund
credit: Michael Steinberg

Concluding remarks

Keep in mind of:

  • The annual performance of last year or the year before last is not important. Please review the annualized rate of return for more than ten years; the longer the better-this principle is applicable for reviewing investors themselves, mutual funds, and your investment advisor.
  • ETFs are truly no-brainer and effortless investment methods that can defeat inflation.
  • Holding costs are very important. These cost are not small money at all, but big money. Investors who don’t pay attention to handling fees, management fees, and taxes (please refer to my post”Tax, inflation and rate are the top three serious killers to investors“), it’s difficult to succeed in the long run.

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