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It's no secret that 2008 was a horrendous year for the
financial markets. Most investors sustained serious damage
to their wealth last year -- damage that, in many cases,
will be very difficult to recover from. As far as who is
responsible for this calamity, certainly there is plenty of
blame to go around. Wall Street titans, reckless lenders and
irresponsible home buyers all deserve their fair share of
the blame; however, there is one part of the financial world
that has not received much scrutiny for their role in the
evaporation of investor wealth, and that is the mutual fund
industry.
The mutual fund industry has control of the majority of
America's retirement assets through 401(k)s, IRAs and
annuities. I submit to you that the mutual fund industry has
effectively teamed up with the media and academia to
perpetuate the theory that the assets they manage always go
up over the long term, and that the only thing investors
need to do is buy and hold their investments for the long
term.
Sadly, a gullible investing public has bought into the idea
that steady investments in mutual funds, regardless of
market conditions, is the way to make their financial dreams
come true. I think this is one of the biggest fallacies of
the investment world, and it's why I think that mutual funds
could be hazardous to your wealth.
Frankly, I can't blame the investing public for thinking
this way. I liken this situation to a person who wants to
eat a healthy diet, but all they hear from the nutrition
industry and the media is that McDonald's is where they
should eat all their meals.
To give you a sense of just how flawed the buy-and-hold
philosophy advocated by the mutual fund industry was in
2008, all one needs do is look at the numbers. According to
the mutual fund industry's own Investment Company Institute,
investors lost nearly $3.7 trillion in mutual funds in 2008.
Yes, that's trillion, with a "T." Yet I ask you, how many
times have you read about mutual funds leading the public
down a losing path? How many times have you heard about a
fund manager whose performance was drastically lower than
their benchmark?
Fundamentally Flawed Investment Vehicles
Unfortunately, my problems with mutual funds don't stop
merely at poor performance or inept fund managers. I think
there are serious problems with mutual funds that have more
to do with the very design and structure of these investment
vehicles. In fact, I now think there are so many fundamental
flaws inherent with mutual funds that they have now become
obstacles to successfully growing your investment portfolio.
The following are five fundamental flaws I think are
inherent to mutual funds, and which make them poor vehicles
for growing your money.
Flaw #1 -- The Fund's Interests are at Odds With Yours
Mutual fund companies have one primary objective and that's
to make a profit. Unfortunately, this profit is not for you,
but rather for them. Mutual fund executives are,
understandably, first and foremost looking out for number
one. Now I will never disparage a company for having a
self-interested goal of making a profit, but when that
profit comes at the expense of your best interest, then it's
a profit deserving of condemnation.
Flaw #2 -- No Transparency of Holdings
A murky understanding of what securities you own at any
given moment is another fundamental flaw inherent to mutual
funds. This lack of transparency essentially leaves you
guessing about what you own and why you own it. I can't
think of a more unsettling feeling in a bear market than not
knowing what kind of toxic assets you're being exposed to.
Flaw #3 -- No Transparency of Fees
Here again we have a lack of clarity, but this time it's
about what kind of fees you are paying the mutual fund for
the privilege of managing your money. Sure, mutual funds are
required to tell you they charge fees, but do you really
know what you are paying for and why you are paying it? Here
again, in this bear market the last thing you need is to be
hit with some obscure fees you don't understand. The
fundamental flaw of mutual funds is that they are able to
bury the specifics of their often very high management fees,
which means you really have no idea what you are actually
paying for and why.
Flaw #4 -- All In, All The Time
The charter of most mutual funds impels the fund's manager
to be allocated to stocks in virtual perpetuity. Most funds
must maintain a significant allocation to the market no
matter what the current conditions may be. It doesn't matter
if stocks descend to near-Depression era values, according
to their charter most fund managers must remain almost
completely in the market almost all of the time. To be
certain, there are a small percentage of funds that don't
have to be committed to equities all of the time, but most
funds do -- and that's perhaps one of their biggest
fundamental flaws.
Flaw #5--Peddling Bad Advice
The fifth fundamental flaw, and perhaps the most onerous for
investors, is the just plain bad advice most mutual funds
dish out. As we've just seen, mutual fund companies have
incentive for you to be in the market all of the time
because that's how they make money. It doesn't matter if the
market undergoes a downward spiral the likes of what it did
in 2008. The mutual fund folks want you to stay the course,
and that's the kind of advice they'll give you when asked.
This advocacy of what I think is a fundamentally flawed
strategy of buy-and-hold investing is the backbone thesis of
most mutual funds. A mutual fund company will never tell you
just to move to cash when things get tough, because it's
just not in their best interest to do so. Because most
mutual funds must stay fully invested all the time, their
concern for managing risk is secondary to their concern for
keeping you fully invested.
The Lemony-Fresh Scent of Flaws
The aforementioned flaws inherent in mutual funds can be
sniffed out by performing a little market research. In fact,
the fundamentally flawed structure of mutual funds leaves a
distinctively lemony residue. Let me explain.
For over 10 years now I've been publishing my quarterly
Lemon List, a rundown of America's worst-performing mutual
funds. Funds that make the Lemon List have failed to measure
up to their peer group average. If a fund can't perform
better than its peer-group average over a period of one
year, three years and five years, then that fund officially
becomes a lemon.
The way I see it, it's one, three, five strikes and you're
out.
My latest Lemon List for Q4, 2008, contains a total of 2,279
mutual funds representing over $795 billion in assets. This
translates into nearly 30% of all funds out of a universe of
almost 8,000 that failed to measure up to even their
peer-group average. The sheer number of funds that fail to
measure up, along with the appalling amount of assets these
funds represent provides solid data backing up the thesis
that mutual funds are flawed down to their very DNA.
I think what scares me most right now is that we are in the
clutches of what will likely continue being a pernicious
bear market. That means we are likely to see even more funds
and even more assets make it on to the Lemon List in 2009.
The simple fact is that the fundamental flaws inherent in
mutual funds and severe bear markets constitute a lethal
combination for the health of your portfolio. If you want to
avoid reliving the market hazard of 2008, then reconsider
your exposure to mutual funds in 2009.
Sincerely,
-- Doug Fabian
Editor, Making Money Alert, Successful Investing, High
Monthly Income and ETF Trader
P.S. The collapse of mutual funds started a long time ago.
What I see now is that it's time to take your money out of
mutual funds, because the whole industry is going to come
tumbling down. It's time for something better. Something
that can reduce your risk, cut your fees 75% overnight,
double your money in four years, and make investing easy.
And it's all revealed in my special report,
so please read on...
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