The Only Way to Stop Losing Money

When you talk to investors about the costs that most affect their investing, you'll hear a lot about broker commissions. Yet in the long run, another type of fee can cost you thousands of dollars -- giving you plenty of incentive to take the next step in your stock market education, and start buying individual stocks on your own.

Mutual funds have huge advantages for beginning investors. When you're first beginning to invest, a good mutual fund gives you several benefits. You can start with a diversified portfolio, even if you have only a few hundred dollars to invest. You can read your fund manager's annual reports and shareholder letters to get insight on your fund's approach to successful investing. And over time, you can add to your investment nearly effortlessly, simply buying new shares whenever you have extra cash to put to work in the market.

But once your portfolio gets big enough, mutual funds start getting much more significant. And during tough times, you need to think twice before you pay thousands of dollars in mutual fund fees. Whether the market rises or falls, you're losing that money year in and year out.

$1,000 pays a lot of commissions
In contrast to mutual funds, brokers are notorious for their fees. The top complaint: You can't do anything without paying something. Each time you buy a stock, there's a commission. Buy five stocks, pay five commissions. Need to sell one? Pay another commission. Meanwhile, most mutual fund purchases and sales are absolutely free.

But there's definitely a price you pay for mutual funds, and the more you own, the more you pay. As of the end of 2008, households owned about $9.6 trillion worth of mutual funds, according to the Investment Company Institute. With an estimated 92 million investors owning mutual fund shares, the math works out to about $105,000 in fund assets for the average investor. The vast majority of these assets are mutual funds.

With an average expense ratio for stock mutual funds of about 1%, the typical investor pays more than $1,000 per year just to cover the expense ratio. And remember, expense ratios don't even include the transaction costs that funds incur to trade stock holdings -- which some analysts estimate can add as much as 2% more in costs annually.

Do-it-yourself investing
Instead, by taking charge of investing your own large portfolio, you can save a bundle. For example, say you own $100,000 in the Pioneer Cullen Value Fund (CVFCX). Because the fund owns only around 40 stocks, you could instead just buy them all in a brokerage account. And because the fund has a very low turnover ratio of 19%, you wouldn't have to make lots of transactions to track the fund's changing holdings.

In addition, by owning each stock individually, you'd open up some options you don't have as a fund shareholder. Take a closer look at some of the fund's top 10 holdings:

Stock

Share of Fund Holdings

10-Year Avg. Annual Return

Microsoft (Nasdaq: MSFT  )

3.45%

(2.3%)

JPMorgan Chase (NYSE: JPM  )

3.22%

1.1%

Unilever (NYSE: UL  )

3.20%

10.3%

Oracle (Nasdaq: ORCL  )

3.16%

1.8%

3M (NYSE: MMM  )

3.08%

7.7%

Covidien (NYSE: COV  )

3.06%

N/A

Devon Energy (NYSE: DVN  )

2.86%

16.0%

Sources: Morningstar, Yahoo! Finance.
Holdings as of Oct. 31. Returns as of Dec. 7.

As a fund shareholder, when it comes to buying and selling, you're at the mercy of the fund. Among other areas, that makes a big difference in taxes. If the fund chooses to sell its long-term winners, you'll pay capital gains tax -- even if the fund loses money overall.

But if you own the shares yourself, you call the shots. Instead of selling shares like Unilever where you have big gains, you can choose to liquidate losers to harvest tax-loss benefits -- or simply stay put.

More importantly, as you gain experience, you'll feel more comfortable putting your own spin on a fund manager's picks. For example, if you like a certain manager but disagree with a fund's holdings in one particular industry, you can instead just focus on the fund's other picks. Eventually, you can take off the training wheels and research your own stock ideas, rather than relying on those of fund managers.

Take control now
When you consider how much you're paying for a big fund portfolio, commission costs seem like a drop in the bucket. Given how much flexibility a brokerage account of your own adds to your investing, finding the right broker really pays off.

Learn how you can pick the right broker to make the most of your investing prowess.

This article was originally published Feb. 19, 2009. It has been updated by Dan Caplinger, who doesn't own shares of the stocks mentioned. 3M and Microsoft are Motley Fool Inside Value selections. Unilever is a Motley Fool Income Investor recommendation and a Motley Fool Global Gains selection. Motley Fool Options has recommended a diagonal call on Microsoft. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy keeps you a winner.


Read/Post Comments (4) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 08, 2009, at 4:51 PM, lewellen180 wrote:

    Agreed - if you have enough to invest, it could be less expensive to buy individual stocks rather than a fund ... if you "mirror" a good fund you get most of the benefits of a good manager for less money.

    And, you have these other neat things you can do - harvest losses rather than sell gains, and so forth!

    Breathless excitement aside, however, doing that will automatically mean you're doing things the manager isn't doing and therefore you're no longer cloning the fund.

    Which means ... you're on your own again.

    No real quibbles with the article, just pointing out that one thing you get for the money you spend on a fund is the fund manager's behavior, plus a time lag on being able to match those actions. (For better or worse.)

    Best,

    - Lewellen

  • Report this Comment On December 08, 2009, at 4:51 PM, lewellen180 wrote:

    Agreed - if you have enough to invest, it could be less expensive to buy individual stocks rather than a fund ... if you "mirror" a good fund you get most of the benefits of a good manager for less money.

    And, you have these other neat things you can do - harvest losses rather than sell gains, and so forth!

    Breathless excitement aside, however, doing that will automatically mean you're doing things the manager isn't doing and therefore you're no longer cloning the fund.

    Which means ... you're on your own again.

    No real quibbles with the article, just pointing out that one thing you get for the money you spend on a fund is the fund manager's behavior, plus a time lag on being able to match those actions. (For better or worse.)

    Best,

    - Lewellen

  • Report this Comment On December 09, 2009, at 7:24 PM, edyboom223 wrote:

    hi

  • Report this Comment On December 10, 2009, at 3:31 PM, ragie wrote:

    I have been thinking along these same lines of late, especially where, at my spouse's 401k ,the only investment option is mutual funds of a certain kind. However, I have found that I can transfer some of those assets into an IRA and then I can take control of them and if I like the funds performance, do what they do but obviously is smaller amounts.

    I have looked at what has been spent with mutual fund fees (up front/end load fees) not to mention redemption fees etc., and decided we could probably all do better off with out mutual funds if we keep to the plan, do the homework, prepare to work at it and keep on top of it. Great article. Thanks!

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