Why Mutual Funds Are Lousy Long-Term Investments(ZT)

Why Mutual Funds Are Lousy Long-Term Investments by Robert Kiyosaki Email this Page IM this StoryBookmark this StoryAdd to your Del.icio.us accountDigg this StoryPrint this Story Good (10 Ratings) 2.6/5 Posted on Monday, June 26, 2006, 3:00AM This past Christmas, I was at a party, and a man who's about 10 yearsolder than I am asked me what mutual funds I invested in. My reply was"None. I rarely invest in mutual funds because of the lack oftransparency. I don't know their fees. And I know there are hiddenexpenses they don't need to disclose to investors." Hearing that, he nearly choked on his spiked eggnog. "What do you meanthere's no transparency? My mutual-fund companies send me a reportevery year." Getting into an argument over mutual funds at a holidayparty is not a way to enjoy the season. Rather than offer myinformation where it wasn't wanted, I thought it better to explainfurther to readers why I don't invest for the long term in mutual funds. Fee Problem A vast number of people think that investing for the long term in adiversified portfolio of mutual funds is the smart thing to do. In myopinion, this ranks among the worst possible investments. The problem with funds is fees. The longer you invest in a mutual fund,the more you pay in fees. I've pointed out before that when I buy apiece of real estate or a stock, I pay the sales commission once, butwhen I purchase a mutual fund, I pay a sales commission for as long asI own the fund (see "So Long Pensions, Hello Fees" ). That's why the return on investment is much lower on mutual funds --and why gains get lower the longer you own them. The reason mostfinancial planners recommend you invest for the long term is simplybecause the longer you hold on to the fund, the more money they make. How Much Do Fund Companies Make? Just how much does a fund company make from investors who hang in therefor the long term? John Bogle, the founder of the very successfulVanguard Group, shed some light on that. He was asked by an interviewer with the TV program "Frontline," "Whatpercentage of my net growth is going to fees in a 401(k) plan?" Boglereplied, "Well it's awesome. Let me give you a little longer-termexample. An individual who's 20-years old today [is] starting toaccumulate for retirement.... That person has about 45 years to gobefore retirement -- 20 to 65 -- and then, if you believe the actuarialtables, another 20 years to go before death mercifully brings his orher life to a close. So that's 65 years of investing. If you invest$1,000 at the beginning of that time and earn 8 percent, that $1,000will grow...to around $140,000." He continued: "Now the financial system -- the mutual-fund system inthis case -- will take about 2.5 percentage points out of that return,so you'll have a net return of 5.5 percent, and your $1,000 will growto approximately $30,000 to you the investor." "Think about that. That means the financial system put up zero percentof the capital and took zero percent of the risk and got almost 80percent of the return. And you, the investor in this long time period,an investment lifetime, put up 100 percent of the capital, took 100percent of the risk, and got only a little bit over 20 percent of thereturn. That's a financial system that's failing investors because ofthose costs of financial advice and brokerage, some hidden, some out inplain sight, that investors face today. So the system has to be fixed,"said Bogle. In other words, the longer you invest, the more the investment housemakes. That's why the financial institutions recommend you invest forthe long term. Occasionally, I will buy a mutual fund. But I'll never hold it for a long period of time. So What Should You Invest In? The next time you hear a financial expert recommend that you "investfor the long term in mutual funds," take a moment to ask them toexplain how their fees work over the long run. I suspect you'll hearsome interesting answers -- if they can answer the question. The reason they'll probably not be able to give you a definitive answeris because most financial experts don't know how much a mutual fund'sfees and expenses are as most funds aren't required to disclose allsuch charges. In other words, there's no transparency. If you're a passive investor, you may want to consider investing inindex funds, which Mr. Bogle's fund company, Vanguard, specializes in(though not exclusively). Simply put, index funds have lower fees sothe investor has a chance of making more money. After all, isn't thatwhy we invest? While index funds have the potential of generating greater returns vialower fees, I would still prefer to be an active investor. Most indexfunds think a 10 percent to 25 percent return is a good rate. Activeinvestors can regularly beat those gains, especially if they stay awayfrom traditional investments such as savings, stocks, bonds, and indexand mutual funds (for more on being an active investor and not apassive one, see "To Diversify or Not to Diversify" ). Summarizing what Bogle is saying, if you invest in mutual funds for along period of time, this is a simplified picture of how the return issplit over the long term -- and who takes the risk. Mutual-Fund Company Investor 80 percent of the return 20 percent of the return 0 percent of the capital 100 percent of the capital 0 percent of the risk 100 percent of the risk If you don't like the above distribution of returns, I suggest you contact John Bogle Email this Page IM this StoryBookmark this StoryAdd to your Del.icio.us accountDigg this Story