Mutual funds have become the Rodney Dangerfield of investing … they get no respect.
Many so-called experts have suggested that they are unsuitable for high net worth investors with complex financial needs. In fact, I have heard on more than one occasion a high net worth individual or talking head on BNN suggest that people should “graduate from mutual funds.”
The financial media is no different in their criticism. A few years back, a prominent Canadian financial journalist once proudly told me that they were, “diabolically opposed to mutual funds.”
The most common alternative to mutual funds is using some sort of forecasting or crystal-ball type alternative like picking individual stocks, which I don’t recommend.
Other alternatives include using exchange traded funds, hedge funds or private investments, which all have their pros and cons, but that is a discussion for another day.
Moving beyond the bravado, more valid criticism, albeit a very broad generalization, is that all mutual funds are high cost, tax inefficient and tend to be inconsistent in their investment style (i.e. the investment style drifts over time). All of which causes them to at best produce unsatisfactory returns, and at worst negative returns.
What these criticisms fail to address is the difference between the structure of a mutual fund versus the underlying investment strategy.
A mutual fund is just a “structure” or way that investors can comingle their investments to have a pro-rata share of a larger, diversified pool of stocks and/or bonds with professional management. That structure is governed by law and regulations and includes clearly defined governance, greater transparency, and accountability.
Where the criticism is valid is when a particular mutual fund is high cost, tax inefficient and has poor performance. But that has nothing to do with the structure, it has to do with the underlying management and strategy.
Consider the following regarding the underlying investment strategies of mutual funds generally:
- The vast majority follows a conventional forecasting approach of stock picking and/or market timing, whereas a small minority follows a more consistent and reliable evidenced based approach.
- Many are high cost, whereas others are low cost.
- Some are tax inefficient, whereas others are very tax efficient.
- Many mutual funds have embedded advisor compensation and marketing fees, whereas others have all of the extra costs stripped out.
- Every mutual fund has an independent review committee. Some of these committees are nothing more than a “rubber stamp”, whereas other committees are very esteemed and prominent.
Given the choice, isn’t it rather obvious what you should choose?
Let me see, would it be safe to assume that something with an underlying investment strategy backed by scientific evidence that is low cost, tax efficient, with no hidden commissions or marketing costs produces better results over time?
So … are you recommending mutual funds?
What I recommend is using an evidence based investment strategy that is low cost, tax efficient and transparent. The structure of the investment strategy, although a secondary consideration, should be in a form that provides daily liquidity, good governance and transparency. If a mutual fund fits the bill for all these criteria, then there is absolutely no reason why I wouldn’t recommend this.
Additional Articles of Interest related to this subject: