This Wealth-Killing Blunder Will Cost You

Over the past year, we've all gotten a crash course in just how much risk you take on when you buy stocks. But some commentators are taking that logic a step further and arguing that the way millions of investors put money to work in the markets has fundamental flaws that simply can't be overcome.

Specifically, the mutual fund industry is nobody's favorite right now. As many investors sit on 50% losses in the stock market -- and sometimes even worse drops in their funds -- it's easy to make a compelling argument against stock mutual funds right now. Like kicking someone while he's down, you can hardly lose by saying you shouldn't have invested in stocks last year when they were trading at all-time highs, especially after the pounding the market has taken lately.

At this stage, all you can do is to wish longingly that you had paid attention to this advice before you saw so much of your wealth disappear.

Hindsight is perfect
The problem, though, is that few people were actually giving this sort of advice back in 2007, at the market's peak. When everything was rosy, most analysts saw no signs of the imminent collapse that actually occurred.

Still, to a critical investor, that sounds more like an excuse than an actual justification. After all, looking back, the warning signs seem obvious. And while you may not have seen them coming, wasn't that the main reason you were paying some mutual fund management team to take care of your money? So that they would take steps to avoid such dramatic losses?

Are investors blameless?
I don't think it's that simple. Sure, some people want to buy into a fund and completely give up responsibility for their investing. But in my eyes, that's the fundamental flaw -- not the mutual funds themselves.

Mutual funds do, in fact, deserve much of the criticism they've taken recently. Many funds only disclose holdings every few months, making it impossible for investors to know from day to day whether their funds own shares of companies they'd rather not invest in. Fees can be horrendous and exorbitant. And plenty of funds underperform the market consistently, year in and year out.

To me, though, that by itself isn't evidence of a flaw in the basic structure of mutual funds. The bigger question is why investors stick with such lousy funds. Take a look at these long-term underperformers:

Source: Morningstar.

The most surprising thing about this table isn't the funds' bad performance, but rather that those funds have managed to keep so large an amount of assets under management. On top of putting together a bad track record, these funds have only rarely had years in which they performed better than their peers. Yet they continue to attract and retain assets from fund shareholders who may never see those funds improve.

Avoid that losing mistake
With mutual funds, as with any investment, you have to know what you're getting into when you become a shareholder. If you're uncomfortable with the lack of transparency, you can buy shares of individual stocks or an ETF -- but then you're the one who has to pay attention to whether they remain good investments. Similarly, index funds have much cheaper fees, but you give up the chance to beat the market's returns.

If you buy funds that fit into your overall investment strategy, they aren't automatically going to make you poor. And although you can't just turn over the keys to your portfolio to a fund manager and stop paying attention, you can feel confident about a fund's future prospects if you do research and due diligence up front.

Read more about how to keep your finances healthy:

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