There are as many mutual funds as there are stocks on the Wilshire 5000 (which actually contains 7000 stocks). Many mutual funds charge a four to eight percent sales fee, a one to two percent advisory fee, and a 12b1 fee which goes for advertising. This in a market that averages ten percent. Less than half of these actively managed funds earn, after expenses, a return that is equal to the market, and that’s in one year. With every subsequent year, the winning funds have less chance of beating the market average again. By year five, the number is down to one in four, and those investors who own a market-beating fund pay higher taxes (due to the fund’s portfolio turnover) and incur greater risk.
Impartial financial writers often advise investors to not even try to beat the market. Instead, buy a fund that replicates the index. The passively managed Wilshire 5000 index fund that I own has no sales fee, no 12b1 fee, and a 0.1% maintenance fee. Furthermore, the portfolio turnover rate is almost nil (compared to 100% or more for many managed funds), so there are few capital gains. I also own a bond index fund that follows the broad American bond market, and a third fund that tracks the EAFE (Europe, Australasia, and the Far East) stock index. I own 50% American stocks, 5% foreign stocks, and 45% American bonds. If I were younger, I would own more stocks, but since there have been whole decades in which the market lost money, I can’t take the risk.
Yesterday, I heard over NPR that the stock market might crash this very week due to the domino effect of mortgage loan defaults. The brokerage houses are in a panic. The hedge fund managers can’t slow down long enough for their in-house shoeshine boys to polish their shoes. Some fund managers have even stopped honoring redemptions.
Maybe the sky is about to fall, but then again stocks are never more popular than at the end of a bull market or more shunned than at the end of a bear market. This is why I mostly ignore the prognosticators. I say mostly, because I understand only too well the twin emotions of greed and fear that drive the market.
Still, I’ve seen the market drop 38% without being tempted to bail. I’m not brave; I just think in terms of shares instead of dollars. If I own 100 shares of a mutual fund, I will still own those 100 shares whether they are worth a lot or a little unless I sell them. This means that I have reason to hope. If I owned 100 shares of stock, it would be a different matter because a person can ride a stock all the way to the ground. By contrast, a mutual fund is spread across many stocks, and my investments are spread further than any actively managed mutual fund. If big company stocks are rising, I rise with them. If small company stocks or Japanese stocks are having their day in the sun, I get in on some of that. If no stocks are going up, I have bonds to fall back on. And no matter what, I won’t pay high fees and taxes.
My only indulgence is 350 shares of a fund that invests solely in oil and gas exploration. It’s breathtaking to watch its movements on a given day, and, over the course of a year, it can go up or down by 80%. I tell myself that I should sell it while it’s flying high, but I love that fund. It’s like having a poisonous snake for a pet. The snake kills your rats, but then you can never trust the snake not to kill you too, and there’s something attractive about that.