Look, I won't lie to you: Mutual funds may be just the thing for you. But if you are interested in hearing about a simple alternative – one that might make you a lot more money – I hope you'll read on.
The crime of the century
Seriously, with the exception of local property taxes, no legal mechanism I've encountered picks our pockets more stealthily or efficiently than the U.S. mutual fund industry. And yes, that includes the dreaded IRS.
Think about it. Uncle Sam takes a piece of every penny you earn, but your mutual fund manager is worse. He's not satisfied with his cut of what your money earns each year (we'll assume for now that he makes you money). No, your fund manager wants more -- much more.
When I show you how much more, you may not believe it, so let's warm you up with a quick example. Step back with me to 1991 ...
Wahoo! My fund manager's a genius!
The economy is stagnant. Saddam Hussein is rattling his saber, and President Bush assures us this won't stand. And you just dumped 10 grand of your life savings into a mutual fund. Good times.
Fortunately, your fund manager doesn't buy the gloom and doom, and he doesn't buy diversification, either. So he rolls the dice on just four up-and-coming growth stocks.
You hit paydirt! Now flash-forward 10 years to New Year's Day 2001 and look at what's become of your $10,000 stake ...
- Amgen (NASDAQ:AMGN): $48,909
- Genentech (NYSE:DNA): $26,348
- Charles Schwab (NASDAQ:SCHW): $192,344
- Ericsson (NASDAQ:ERIC): $37,101
Happy New Year! You're sitting on about $304,000! But wait. Mutual funds have a price, and it may be higher than you think.
Surprise! Your $10,000 isn't worth $304,000
You see, assuming your fund manager hits you up for a 2% fee (not cheap, but hardly unheard of), you would owe him about $6,000. That seems fair enough. After all, the fellow just made you $304,000. But there's a catch.
That $6,000 is for the last year alone. You've been paying out every year along the way. In fact, by New Year's Day 2001, you'd have paid out more like $17,000 in fees, and the lost profits on those fees would have cost you a lot more -- another $50,000 or so.
And that's over 10 short years. Now imagine if you'd invested $20,000 instead of $10,000. You'd be paying twice as much! And what do you get extra for that extra money -- for paying twice as much? Not a darn thing, as far as I can tell.
Oh, yes, it gets worse
Now, what if it turns out you're paying for very little in the first place? I mean, let's face it -- you're not going to buy into a superfund like the one I just described. Your fund manager won't be a genius. More likely, he'll be an Ivy League MBA looking to keep his job and follow the herd -- or worse.
Don't believe me? Check out a list of the most widely held institutional stocks. I'll spare you the trouble: You won't find a lot of surprises -- more like a bunch of Comcasts (NASDAQ:CMCSA) and Pfizers (NYSE:PFE). Both stocks are roughly 70% owned by mutual and pension funds, likely yours included.
Worse, even if your manager did stumble on a stealth bomber like game-developer Activision (NASDAQ:ATVI) back in 2000 -- or any other 10-bagger, for that matter -- what are the chances he actually kept you in for the ride? Not good.
Most mutual funds turn over their entire portfolios every year. Chances are your guy bought and sold it many times over. You guessed it: In addition to the outrageous annual fee, you'd have gotten nickel-and-dimed on 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 your money in a mutual fund, your fund manager takes a cut of everything you have ... year after year after year.
Worse, your manager might not only fail to keep pace with the market in any given year (remember, most do), he or she might actually lose you money – like he probably did in 2008. 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.
If you ask me, that's just wrong. Yet for all that, you may still have no interest in researching and buying your own stocks -- even with the help of someone you can trust. If so, mutual funds may be the only game in town. It definitely beats staying out of stocks over the long haul, but you can probably agree that it's a broken model as far as investors are concerned.
Something better to consider
If you want your wealth to grow, but balk at buying a house in the Hamptons for somebody you don't even know, here's an alternative a lot of folks are considering. Start managing some of your own investments. It's not that hard, especially when you accept a free trial of David and Tom Gardner's Motley Fool Stock Advisor investment newsletter free for 30 days.
These guys founded The Motley Fool, and they're two of the best stock pickers I've come across. And while they can't guarantee they will always help you outperform the S&P 500, that's exactly what they've done over the past seven years – by an astonishing 50 percentage points. And beating the market -- something 75% of mutual fund managers do not do -- is David and Tom Gardner's sworn mission.
Best of all, as your portfolio grows, your costs don't. Stock Advisor won't set you back two grand a year to join the $100,000 club ... or $120,000 a year to be the $6 million man (or woman). Getting wealthy should be your goal, after all -- and it isn't one you should approach with mixed feelings.
Listen, I know there's still a lot of uncertainty out there. It's only natural to feel uneasy, but this is no time to give up on stocks for the long term. Quite the opposite. To steal a phrase from that sour-faced know-it-all on the TD AMERITRADE commercials, "You can do this." And you don't have to do it alone. For a little help, give Stock Advisor a try. To learn more, click here now.
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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. Schwab and Activision are Motley Fool Stock Advisor picks. Pfizer is an Inside Value choice. The Motley Fool has a disclosure policy.
