bluecollardollar: on mutual fund investing

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The mutual fund investor has a great many more options available to them in the post-Great Recession marketplace. The question is: are they right for you as you make a retirement plan using 401(k)s or IRAs?
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on mutual fund investing

From a Distance
First, let's discuss the advantages of mutual funds, the distanced look. Mutual funds offer three things to every investor: a professionally managed portfolio that if constructed correctly - and not all are - can provide an advantage over being an individual stock picker; choice of thousands of different types of mutual funds; and ease of access through 401(k)s, through IRAs and through every brokerage.

Breaking those opportunities down further finds us embracing the mutual in mutual funds. Enormous pools of investors with similar goals have come together seeking diversification, proper asset allocation and more importantly, profits. The enlistment of a manager (sometimes one person, sometimes a team, sometimes an algorithm or an index) guides your dollars coming in (inflows) and protects remaining investors when other investors sell (outflows). Based on the charter of the fund (essentially what it is designed to do), the fund manager crafts a portfolio.

Choice, as I said earlier, from a distance, seems like exactly what all of us need. But the choices are often so overwhelming as to create more confusion than convenience. With tens of thousands of funds to choose from, we often turn to ratings agencies to help us sift through the choices. Some use stars, others simply compare funds to a benchmark, a fund that mimics a similar swath of the market as an index. Many simply choose the index and call it good.

Ease of access once again doesn't translate into guaranteed quality. Most of us access mutual funds through our retirement plans. These closed investment arenas provide many of us with our first look at investing and in many instances, we only have mutual funds to pick. Individual Retirement Accounts or IRAs work in the same capacity only with a much broader selection - the whole of the mutual fund world.

Up Close
The trouble with mutual funds presents itself when you look much closer. Fund managers often are given credit when a fund performs well (beats the benchmark index) and perhaps the manager does deserve kudos for his skill. But too often, too many fund managers don't perform well enough to beat the benchmark. These funds, called actively managed mutual funds make up the lion's share of choices and when less than 20% of them can do better than investors expect, we ask the manager)s) why.

We ask why do you charge so much to not do as expected? We ask this sometimes in error. 2011 was no picnic for any investor yet we hold our fund managers to a higher standard. We expect them to make money when others can't. When the cost of the fund (the fees) are added into the return (we expect), the performance of the fund is questioned. Managing a fund is no easy feat, even in good times, and the costs have come down from their historic highs. And they need to get paid.

The advantage a small investors has, even to some degree inside of a 401(k), is to walk away. And you may look to index funds. or you may be listening to the siren call of exchange traded funds or ETFs.

Recently, on my radio show (Financial Impact Factor Radio) I have asked if this is a wise move. From long-time mutual fund investors, and I am one, the answer is one of effort. Index funds, if you have any and you should, provide the same cost and ease of investment opportunities as ETFs do. Selling one apple for another is not a lot of effort but also not worth the savings.

Inside a 401(k), ETFs are still somewhat scarce. They are making inroads as an increasing number of mutual fund families are introducing these investments to plan participants. Here, the effort is worth taking. The only caution I offer comes from the education you bring to that decision.

ETFs can be indexed to small slices of the marketplace, sometimes so small as to create risk you hadn't anticipated. And because they trade all day long on the exchange, the temptation to do so may find you missing market moves that buy-and-hold investors would receive.

I think that mutual funds are not going away anytime soon. But the room for improvement in how they invest, how they charge for our interest, and how they balance the need to stay vital with our needs to increase our wealth in tumultuous marketplaces is quite vast. Certainly not insurmountable.

One last thing: it is up to you to use them for these investments to work. Increased contributions, an effort at education and a clearly defined image of who you are will benefit all investors, But more so for the mutual fund investor.

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