Have you ever actually thought about what a mutual fund actually is? Ever thought about what you are actually paying for when you hold one? This article will detail why I encourage investors to at least consider the idea of taking their investments out of traditional mutual funds and fully into their own hands.
Many financial advisors in both the professional space as well as the “amateur” space will recommend that many individuals focus on saving for retirement via low-cost mutual funds, index funds and ETFs (exchange-traded funds). For some, this may be the correct path, it really does simplify investing for those that want to focus their efforts and time elsewhere in their lives. However, nothing in the investing world ever comes without a cost.
As an aside, as much as I am a massive fan of Warren Buffet, he may scold me for this article J. He has been very clear throughout his career that he recommends for the majority of the general investing population, just stick your money into a low-cost fund and forget about it.
Reasons for My Strategy
Lack of Mobility in Fund Investing
We currently live in a time of extremely turbulent markets. Does anyone expect that this will change any time soon? The move toward globalization, or the lack there-of, has economic fears around the world and the United States changing on a daily basis. Where does that leave the middle of the road investor?
One sector of the financial markets may be down on one day, while another is up. I see it in my portfolio alone almost every single day, REITs and utility stocks may be up while the industrial market tanks, or vice versa. If you own a single fund or maybe let’s say 5 funds that generally own all of these items, what will that usually get you? At a zero-sum gain. You can buy more of any of those funds, but by doing that, you may be overpaying for one security while simultaneously getting a deal on another. Why not just buy the deal of the day, and save the overpriced security for another day?
Purchasing individual stocks allows you extreme mobility in the allocation of your capital to the best deals on any given day, week, month or year.
Paying Wall Street’s Salaries
To some extent, this is a personal choice, as mentioned earlier. If you are not comfortable making your own investment decisions, paying someone else to do it may be the best option for you. I just want you to re-think this approach and at least consider other options.
Even the cheapest mutual funds and ETFs charge you some type of yearly fee, usually based on a percent of your dollar investment value in their fund. Here are just a couple examples of the cheapest and most highly touted funds and the dollar amounts those fees equate to on a yearly basis for you the investor.
Pretty crazy right? Sure, $10 a year when you have a $10,000 balance is nothing right? Of course not, but you’re also not retiring on a $10,000 nest egg either. Move farther to the right in the graphic and look how much you’ll be spending each year, gradually increasing your fees as your balance grows.
To put these fees in perspective, a trade in my Fidelity Brokerage account costs me $7.95 per trade. On a fairly modest $200,000 account balance I’ll be paying $196 dollars a year to a fund to hold my money for me. At Fidelity, that is almost 25 trades a year, or 2 every single month. Ok, still not that crazy you say. Alright then, now I am closer to retirement, or better yet, early retirement, I have built my nest egg into a $1,000,000 balance (first off, kudos to me J). Now I am paying the fund $980 per year, that’s 123 trades a year! Alright, now we’re getting somewhere, unless you are an active trader, who is making 123 trades, or 10+ trades a month? I know I won’t be.
This is a scalable concept that applies to just about any investor and balance size. If you’re trying to retire on a $1,000,000 nest egg, $980 a year or around $80/month, matters to you, does it not? By the same token, if you are trying to retire on $5,000,000, it’s likely true that $4,900 a year, or around $400/month matters to you in the same manner.
It is important to note that these funds listed above are some of the best of the best, fee expense ratio wise. It would be quite easy to find other funds that charge much higher fees and you can deduce on your own that this would obviously compound the issue at hand.
The craziest part to me about this entire calculation process is once I am retired or at least financially independent, I aim to live off my passive dividend income, meaning my buying and selling is likely going to drop off, to either very little or none. These funds on the other hand? Well, they plan on continuing charging these fees on your portfolio in perpetuity. Might I also add, these fees are charged whether the fund gains value, or loses value, you simply cannot avoid them.
Funds focus on yearly performance returns, rather than income
I am not sure about you, but I care a great deal more about the income that my investment portfolio generates than the actual balance of my portfolio. Sure it is fun to see the balance cross milestones, who doesn’t enjoy that, but it is much more fun to see my investment income creep closer to covering my expenses and beyond.
Funds provide very little forward looking information regarding their dividend (distribution) payouts. You have access to past distribution information, but forward looking distributions are relatively unpredictable and will not necessarily reflect past payments. Individual securities have more information in this arena. Through individual stocks you have the ability to make purchases to fit your income goals, you can chase yield (not necessarily recommended), search for Dividend Aristocrats (companies that have increased their payouts for 20 straight years), or find yourself somewhere in between, depending on the nature of your investment style.
I truly would like to get a feel of what the personal finance community thinks on this subject. I am very anti-fees of any kind, so I do everything in my power to avoid mutual funds or any form of managed fund. Are you investing in mutual funds because that is the only option in your 401k? Or are you using ETFs & mutual funds as investment vehicles for your brokerage accounts as well? Do you agree with my take? Disagree?
When it comes to the stock market and dividend investing, I will be investing in individual stocks and trying my best to keep my investment costs low. On a yearly basis I will be tracking my investment fees to see if I am keeping my costs low and comparing them to the fees associated with other investment alternatives.
Disclosure: I have no positions in any investments listed in this article.