Listen, mutual funds may be right for you. But for most of us, they're an expensive way to invest. If you're looking for an alternative that can help you make some money and keep more of it -- take a few seconds to read on.
I want what's coming to me!
With the exception of local property taxes, no system known to man picks our pockets more efficiently than the U.S. mutual fund industry. Yes, that includes the IRS.
Think about it. Uncle Sam wants a piece of everything we earn, and that's trifling. But your typical mutual fund manager is worse. These guys aren't happy with a cut of what we earn each year. (We'll assume for now that they make us money -- unlike in 2008.)
No, our fund managers want more -- much more. When I tell you how much more, you may not believe it. So I'll warm you up with a quick hypothetical.
Wahoo! My manager's a genius!
The year is 1990. The economy is stagnant, Saddam Hussein just invaded Kuwait, and President Bush assures us that "this will not stand." D'oh! You just dumped 10 grand in a mutual fund.
Don't worry -- your fund manager doesn't buy the gloom and doom, and he doesn't buy diversification, either. He buys technology. To prove it, he rolls the dice on just four tech stocks.
You hit paydirt! Flash forward to New Year's Day 2000, and just look at what's become of your $10,000 stake in this guy's superfund ...
- Cisco Systems (Nasdaq: CSCO ) : $1,673,750
- Applied Materials (Nasdaq: AMAT ) : $178,239
- Sun Microsystems (Nasdaq: JAVA ) : $158,689
- Qualcomm (Nasdaq: QCOM ) : $298,021
Add it up, and you're sitting on $2.3 million, right? Not so fast. Mutual funds have a price, and it may be a lot higher than you think.
Your $10,000 isn't quite worth $2.3 million!
Assuming your fund manager hits you up for a 2% fee (not cheap, but hardly unheard of), you would owe him about $37,000. That seems fair enough. After all, the fellow just made you $2.3 million. But here's the catch.
That $37,000 in fees is for the last year alone. You've been paying out every year along the way. In fact, by New Year's Day 2000, you'd have paid that rascal more like $70,000 in fees, and the lost profits on those fees would have cost you a lot more -- another $340,000 or so. And that's over 10 short years!
That's a high price, but it gets worse. Imagine if you'd invested $20,000 instead of $10,000. You'd be paying twice as much. And what do you get for all that extra money -- for paying twice as much? Not a darn thing, as far as I can tell.
Oh, yes, it gets worse still
Now, what if it turns out you're paying for nothing? I mean, let's face it, you're not going to stumble across a miracle fund like the one I just described. Your manager won't be a genius. More likely, he will be an Ivy League MBA looking to keep his job and follow the herd -- or worse.
Don't believe me? Look at any list of widely held institutional stocks. I'll spare you the trouble: You'll probably find "blue chips" like Home Depot (NYSE: HD ) and Merck (NYSE: MRK ) , alongside other usual suspects. Now, run down the top holdings in your mutual funds. See anything familiar?
Worse, if your fund manager does stumble on a category-killer like Amgen (Nasdaq: AMGN ) before it's a household name, what are the chances he would actually hold on for the entire ride? More likely, you'd have been in and out many times over. You guessed it: In addition to the outrageous annual fee, you'd have been killed with taxes and transaction costs.
And it gets worse ...
Because here's the thing. In any given year, the IRS can tax you only on what you earn that year. When you invest in a mutual fund, your fund manager takes a cut of everything you have – all your assets in the fund -- year after year after year.
Worse, your manager not only might fail to keep pace with the market in any given year (remember, most do), he or she might actually lose you money. Yet, even if you don't make a penny in year 11 of our previous example, you'll still have to hand over another few thousand dollars in fees.
That stinks. Yet, for all that, you may have no interest whatsoever in researching stocks on your own -- even with the help of someone you can trust. If so, mutual funds may be the only game in town. They definitely beat staying out of stocks over the long haul, but you can agree that it's a dubious model.
Something better to consider
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This article was originally published June 13, 2006. It has been updated.
Fool writer Paul Elliott doesn't own any of the stocks mentioned. You can see all of David and Tom Gardner's Stock Advisor recommendations immediately with your free trial. Home Depot is a Motley Fool Inside Value selection. The Motley Fool has a disclosure policy.