The Truth About Mutual Funds

Truth About Mutual Funds
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The good, the bad and the ugly

We're not mind readers, but our guess is that you clicked here looking for answers to two main questions:

Q: Are mutual funds a good investment? And,
Q: Which ones should I pick?

Without mincing words, here are our answers:

A: Some are. And, A: The ones that consistently outperform all the others.

We're not trying to be cheeky. (OK, you caught us, we are.) It's just that the world of mutual fund performance is more complex than any 14-syllable answer that we could offer. There are thousands of mutual funds from which to choose. And there's no shortage of bold-faced statements touting them. Advertisements in newspapers flaunt a fund's "five-star" status. Banner ads brag about "the NUMBER ONE FUND in America" while commercials hype "top returns over the last six months."

It seems there are thousands of funds out there that have done really, really well. Just choose one, already!

What? You want more than seven words in bold type on a blinking banner to make sure you're making the right investment?

Good for you. The sad fact is that the vast majority of mutual funds underperform the average return of the stock market. Some simply pick bad stocks. Others pick stocks fairly well, but not well enough to compensate for the costs of the fund. Remember, fund shareholders have to reduce their returns by whatever costs are imposed by their funds.

In addition to fees, there are four other pitfalls mutual fund investors have to watch out for:

  • Dubious management. Given how many funds there are, not everyone can be above average. Many mutual fund managers have proven no better at picking stocks than the average nonprofessional, but charge fees as though they are.
  • No control. Unlike picking your own individual stocks, a mutual fund puts you in the passenger seat of somebody else's car.
  • Dilution. When mutual funds own too many holdings, even insanely great performance by their best ideas gets watered down when you look at their overall performance.
  • Buried costs. Many mutual funds specialize in burying their costs and in hiring salespeople who do not make those costs clear to their clients.

Ready for some good news? Thought so. We promise there's some on the next page.