In case you intend to invest your money into stocks and ask your banker for a way to do so, you get to a high degree of certainty the answer: ‘Invest in a mutual fund’.
A mutual fund pools the money of you and thousands of other investors and – this is the banker’s best argument – this money is permanently monitored by a highly competent and professional fund manager.
If that’s not enough to convince you, the banker will add: ‘A mutual fund invests sometimes in hundreds of different stocks, thereby minimize your risk’.
If you still have doubts, he will show you some performance charts (which you probably do not fully understand) and to close the deal, your bank-adviser will tell you, that it’s cheaper to invest in a mutual fund than buying individual stocks.
Your money will be professionally managed, the investment is safe and all this to a good price – what else can you expect?
Millions of private investors around the world followed that advice and invested their money via mutual funds.
Well, if I could give you an advice, I would tell you, not to follow them.
First, the ‘highly competent’ fund managers did a terrible job over the last 10 years. I would never make such an accusation, if it weren’t true and therefore I quote the respectable ‘Financial Times’:
“Nine out of ten actively managed European equity funds have underperformed their benchmark over the past decade, intensifying pressure on stock picking asset managers to prove their worth.”
(if you want to read more check the full article published October 25, 2015)
So the first and supposedly best argument of you banker is not exactly true.
How about safety? Well, if safety is your prime issue when you invest, you shouldn’t invest in stocks at all. Neither direct or via mutual fund.
But it’s true, a mutual fund who invests in hundreds of stocks involves a relatively modest risk to a stock picker, who only holds a handful of individual stocks.
Ok, but at least, it’s cheap to invest into a mutual fund. This is about the biggest lie you will hear when talking about mutual funds. Why? Exactly the high costs of a mutual fund are a major factor for the lousy return you get.
Now, in each mutual fund brochure you will find, if you look carefully, the ‘total expense ratio’ which includes management fees, administrative costs and marketing. That indicates the ‘total’ fees in percent you have to pay each year – actually, it’s simply deducted from your investment.
Just don’t trust this figure, it’s only the tip of the iceberg.
The mutual fund industry hides costs through a layer of financial complexity and jargon. Some critics say that mutual fund companies get away with the fees they charge only because the average investor does not understand what he pays for – and I agree with that view.
A part of these high fees you pay find their way back to your bank – maybe you understand now, why your banker is so eager to sell you a mutual fund.
Now, you may think, it’s easy to criticize, but what’s the better solution for me?
The inability of the mutual fund industry to satisfy investors created their biggest competitor – and thereby an excellent alternative for you. Better in performance, cheaper in fees, at least the same degree of safety and much more transparent: this alternative is called Exchange Traded Fund or ETF.
An ETF is tracking 1:1 a public stock market index, the S&P 500 or the EuroStoxx 50 for instance. You know what you buy.
ETFs can be bought and sold via any online broker that deals in shares and can be traded whenever you like during normal market hours, unlike mutual funds that can only be traded once a day.
The annual costs are low compared to a mutual fund. An ETF is a passive investment, so, for instance you don’t have to pay for a ‘highly competent’ professional money manager.
See chapter 8 for further details. There you also find a brochure published by the ‘Bursa de Valori Bucuresti’ about ETF’s.
Now, with all the advantages of an ETF, keep in mind, you still investing in stocks. The performance of an ETF is linked entirely to a stock market- or sector index that rises or falls in any given period. At least, your performance will not suffer by high fees usually charged by mutual funds.
So next time, your banker is proposing you a mutual fund as a good investment, just smile and ask for an ETF – it’s a much better alternative.
New York 1929 – Shanghai 2015 Another time, another place – but some intriguing parallels around the stock market. The crash in New York of 1929 led to a worldwide economic depression. What happens, when China crashes? This is the subject of the next chapter: http://www.theleader.ro/the-shoeshine-boy-the-hairdresser/