Whatever You Do, Avoid Mutual Funds

This is your red-letter day, dear reader. If you hadn't happened on this article, your life might have unraveled in a most unfortunate way. You might have -- gasp! -- invested in mutual funds!

As Shakespeare might say, "Heaven forfend!"

I'm here to steer you away from dastardly mutual funds and toward more sensible investments. Such as ... well, I'll think of some soon. In the meantime, let me list the countless drawbacks of mutual funds.

Diversification
If you invest in a mutual fund, you'll instantly be invested in, say, 50 to several hundred stocks (or bonds, or what have you). Invest in a broad-market index fund -- for example, one based on the S&P 500 -- and you'll own a stake in 500 of America's biggest companies, such as Alcoa (NYSE: AA  ) , Deere (NYSE: DE  ) , and Merck (NYSE: MRK  ) . Over many decades, the S&P 500 has averaged annual gains of about 10%.

That's nice, but an average of just 10% per year? Sure, that's more than the long-term average gains of bonds, real estate, and lots of other things. But come on, you gorbellied, knotty-pated hugger-mugger -- that's playing it too safe!

If you invest all your money in just one or two stocks, you might do much better than 10%. Johnson & Johnson (NYSE: JNJ  ) , for example, sports an average annual return of 16% over the past 20 years, while Lowe's (NYSE: LOW  ) has averaged 20% and Intel (Nasdaq: INTC  ) has averaged 17%.

Of course, not every company fares as well. General Motors (NYSE: GM  ) has averaged 0% over the same period.

Professional management
Some favor mutual funds because they allow trained professionals, some with sound ethics and deep insight, to invest your money for you. Well, I suppose that's fine -- if you're a fobbing, clay-brained measle.

Don't you have any respect for yourself? Do you really need someone else to manage your money? I suppose you don't pull your own teeth, either, preferring to leave that to a "professional." And how hard is it, really, to rewire a house? Electrician, shmelectrician.

Low cost
OK, so mutual funds, at least the good ones, don't cost too much. Investing advisors can take 2% or more of your assets each year -- plus a share of your gains -- in exchange for their professional guidance. In comparison, some index funds charge less than 0.25%, while many well-managed mutual funds charge around 1% or less.

If you wanted to buy into 20 companies on your own, it wouldn't be cost-effective to do so without many thousands of dollars at your disposal. But with mutual funds, you can spread as little as $1,000 or less across a variety of companies.

Of course, you could put all your money in one stock. Sure, it's risky, but it won't cost you much, relatively speaking. If you plunk your entire $50,000 investment into one stock, the brokerage commission might be just $10 or $25 or $50. That's peanuts. There's your low cost, you yeasty, bat-fowling coxcomb, you.

Dollar-cost averaging
Oh, you just want to have your cake and eat it, too, don't you, you puking, ill-breeding canker-blossom? You want to be able to add to your investments regularly over time, without incurring copious commission fees? You like that you can regularly invest in a few mutual funds painlessly and inexpensively?

Fine. Suit yourself, you droning, rude-growing pignut.

My simple plan of putting it all in one stock makes dollar-cost averaging easy. If you're just plunking $25 at a time into stocks, and paying a $10 commission to do so, though, you're not doing yourself too many favors.

More "advantages"
I know. You can cite other so-called advantages of mutual funds. They make record-keeping easier, for example. They're very liquid, meaning you can cash out quickly if you need to (as opposed to, say, real estate).

There's even a wide array of funds to choose from, including many that focus on companies by size, geographic region, industry, social responsibility, growth, or income. Go ahead and dwell on these if you want, you infectious, swag-bellied vassal.

And you, too, my fellow Foolish writers, you frothy, pox-marked gudgeons. I know that many of you look kindly on mutual funds. Rich Greifner, I know you think that funds are the "Best. Investments. Ever." Tim Hanson and Brian Richards, I know you think you've found the market's 10 best funds. There's even a Fool writer who thinks you can double your money with funds!

That kind of pro-fund enthusiasm must be why we launched an investment service several years ago that's dedicated to introducing investors to some "top-notch" mutual funds out there. I suppose there's some sense to that, since many weedy, half-faced mammets will still opt for mutual funds, no matter how much common sense I try to beat into them. (And OK, I concede that the newsletter is doing rather well, with its picks beating the market, 27% vs. 6%.)

So go ahead, you beslubbering, flap-mouthed harpies. I invite you to sign up for a free trial of our Motley Fool Champion Funds newsletter, which offers regular fund recommendations monthly in an easy-to-digest format. A free trial gives you access to all past issues, so you can read about each recommendation in detail ... you goatish, earth-vexing nut-hook.  

This article was first published July 16, 2007. It has been updated.

Longtime Fool contributor Selena Maranjian owns shares of Johnson & Johnson. She tapped the services of a Shakespearean insult generator for this article. Johnson & Johnson is a Motley Fool Income Investor pick. Intel is an Inside Value recommendation. The Motley Fool is Fools writing for Fools.


Read/Post Comments (3) | Recommend This Article (10)

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 June 23, 2008, at 8:32 PM, d3wilbur wrote:

    Sound ethics? Deep Insight? The managed mutual fund industry seems to have very little of either. Scandal after scandal catches them abusing the system to get rich with your money at your expense while something close to 70% of managed funds underperform the S&P 500.

    Buy Index Funds. You'll nearly match the index if you choose a good fund (cough VANGUARD cough). That'll beat the pants off of the managed funds and you'll have better tax performance to boot.

  • Report this Comment On June 23, 2008, at 9:05 PM, gaucho420 wrote:

    Ridiculous...and its funny, its sites like Motley Fool that have made me invest for myself and ditch mutual funds!

    I would highly recommend that anyone with a little bit of time and knowledge avoid mutual funds, AT ALL COSTS.

    I'm up over 15% to the market averages YTD with the money I manage myself (5 diversified stocks) while my mutual funds are down 22%...the one's managed by the so called "pros". Thanks to the strength of my own picks, I'm still up overall by about 5%.

    So thank you Motley Fool for all the other articles that tell you how to do it yourself, as they are way better than this one.

  • Report this Comment On June 26, 2008, at 12:21 PM, kamuirei wrote:

    "5 diversified stocks"

    I once had 5 diversified stocks... one was FDG, another was AHM - look at the charts. Overall I made money (and was diligent enough to get out of AHM early).

    However, I sleep a heck of a lot better with ETFs as my core retirement (IJJ / IJS - I'm 23 now, go compounding). I still keep about 20% of my portfolio in hand picked stocks as well.

    However there is certainly a case for mutual funds. My parents are entirely invested in mutual funds, several of which I've picked for them. (Don't ask your kids to do that... ever) The reason they do this is the reason for most people - time.

    Building a diversified portfolio out of stocks is time consuming and stressful. They don't have much time to spare and have enough stress to deal with. However, their 401K's do have a few good funds in them, such as Vanguard Wellington. It has a .27% fee - 65% stocks, 34% bonds. For their age and risk tolerance, that's an excellent fund with minimal costs.

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