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ETF's and mutual funds: good or bad?

Updated on December 8, 2012

Why I do not like mutual funds.


For investors who will depend on their investments to create the income they need for retirement; the income needed to replace wages, I do not like mutual funds or ETF’s.

The biggest reason for not investing in mutual funds is what has happened to the broad market over the past decade. The broad market has gone up and down and gone nowhere. If you invested in stocks via a typical mutual fund or ETF that tracks the market, your investments will have gone up and down and in the end basically nowhere.

The reasons people use mutual funds to invest for the future include ease of investing, expert professionals managing the investments, hedge against massive and quick corporate failures and low cost. Let us look at each of these.

Ease of investing is important to many investors, especially new investors and those with limited amounts of money to invest. However, for mature investors who want to use their investments to create income, I think it is easier to manage a handful of carefully selected individual income producing stocks, than it is to try to figure what exactly you own in one or more mutual funds.

Morningstar does have a tool that helps you analyze mutual fund holdings so you can find out if all your money is in one stock or one industry or learn if it is truly diversified. This tool has disadvantages because mutual funds tend to report what they owned 30 or 90 days ago. It is very difficult to determine what you actually own when you invest in mutual funds. Therefore, ease of investing has a distinct downside, it is not so easy.

Regarding the concept that professionals are managing your money is, in my opinion, over rated. The stock market depends on experts on each side of a trade. One expert likes a stock and buys it from another expert who does not like the stock. They are both professionals and experts. Even with knowledge of a mutual fund’s investment objectives, you do not know if your professional is on the correct side of a trade.

Mitigating risk by spreading your money among several stocks within a mutual fund sounds good on paper. However, this type of hedging your bet is not without disadvantages. Yes, stock performance averages out so you have less risk of an individual company’s failure but you also miss out on the return from the one or two stocks that have meteoric performance.

With individual stocks, invested with great discipline, you can manage your risk by investing in companies with good fundamentals and using stops to control down turns. When you do hit a home run, you get the full benefit. If you invested your retirement savings in good quality dividend stocks that I call Dividend Machines a decade ago, your income from these stocks would increase every year. If you are in the savings phase of life and reinvested those dividends, you could very easily have added 30-100 percent to your total investments just by buying more shares through dividend reinvestment.

Mutual funds, even no-load funds, have a way of nipping away at your assets with fees. They charge you fees just for holding on to your money. They have to pay the experts that manage the money and we all know these professional managers do not come cheap. Even mutual funds that report low expense ratios still have to pay these costs of managing your money.

Moreover, mutual funds have to market their funds and many pay 12b-1 fees to distributors. All of these little fees can eat away at your returns. Buying and selling stocks also cost you trading fees. However, once you select a good company, you pay only once to buy the stock. You can reinvest your dividends for free. With electronic trading platforms at most brokerages, your trading fees can be minimal.

If your investing goal is to create income in the future, I would encourage you to develop the skills necessary to manage a handful of income producing stocks by yourself.

I am here to help you. See my very first post on my website regarding income investing http://www.themoneymadam.com/2010/10/four-criteria-for-buying-stock.html

Very Truly Yours,

TheMoneyMadam

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