Solomon once wrote, “Where there is no guidance the people fall, But in abundance of counselors there is victory.” (Proverbs 11:14 NASB) In the world of investing, there is no shortage of people willing to give you advice. From mutual fund offerings to investment advisors to insurance salesman, everyone wants to get in the game of advice. But could this advice be detrimental to your faith and wallet?
The other day I read a puzzling report about how mutual fund inflows were the highest in nearly two years. Strategic Insight, a firm specializing in mutual fund consulting reported that over $136 billion flowed into stock and bond funds during the 2nd quarter of 2009. The money going back into the market isn’t the troubling part; it’s the amount going into mutual funds, especially retail mutual funds. Retail mutual funds tend to have layers of hidden fees.
Here are 5 reasons why mutual funds may be a bad idea for your family:
1. The fund manager’s values and interests often are in direct opposition of yours
When I think of investing, I am often reminded of Mark 8:36, “What good is it for a man to gain the whole world, yet forfeit his soul?” I believe this verse has much wisdom that can be applied to one’s portfolio. What is more important the amount of profit or the source of that profit?
Mutual fund companies seek one major goal: to make a profit. This profit often comes at your expense. In 2008, almost every equity mutual fund lost money yet mutual fund companies kept collecting their fees. They make money regardless of whether or not you ever see a profit.
On top of that, many funds invest in companies that directly oppose your values. They are free to invest in companies supporting abortion, pornography, alcohol, tobacco, homosexual activism, and embryonic stem cell research. Do you really want to profit from these industries? The heart of faith-based investing is seeking companies you could be proud to own: companies making a positive difference in our society all the while avoiding companies that are morally polluting our culture. Though the question you must ask yourself…is…will God bless your investments if they go to support efforts that are contrary to the bible? That’s the one that should keep you up at night…
2. A lack of transparency
It is very difficult without proper tools to have any understanding of what you truly own inside of your mutual fund. The lack of transparency essentially leaves you in the dark as to where and in what you are investing. Do you own assets that violate your values? Do you have exposure to companies going bankrupt? The lack of an ability to “know what you own” is a major disadvantage for those seeking to align their faith and values with their investment plans.
3. Supersized fees
The biggest problem I have with mutual funds are the high-level of fees. Even when you “think” you are paying 1 percent a year, you may be shocked to “know” that the fees you are paying actually exceed 4 percent. Over time, this can mean thousands or even millions of dollars. The longer you invest in mutual funds, the more you pay in fees. In The Faith-Based Millionaire, I wrote about how a 1 percent fee quickly turns into a 4 perfect fee.
So how does 1 percent become 4 percent? If you look at the fixed expenses of a mutual fund, they are included in what is known as the Annual Expense Ratio (found online or in the fund’s prospectus). Every mutual fund and exchange-traded fund (ETF) charges this fee. “No-load” funds (no commissions when you buy or sell shares) still charge annual fees. The expense ratio pays for the fund’s recurring operating costs (such as salaries, research costs, technology, and service, to name a few), but it does not cover trading and other costs. Morningstar, the leading independent third-party mutual fund rating company lists the average expense ratio as 1.56 percent per year.
What are not listed in the expense ratio are variable costs. The biggest variable costs are brokerage commissions and trading expenses. Whenever the fund manager buys or sells a security, he pays brokerage commissions—just as you would if you were to buy or sell a stock or bond. Typically, funds spend tens of millions of dollars in trading costs per year, and these expenses are not included in the Annual Expense Ratio or even disclosed in the prospectus. To find these and other expenses, you must look in the fund’s Statement of Additional Information (SAI).
These additional expenses are difficult to determine, but a 2007 analysis by Virginia Tech, the University of Virginia and Boston College revealed that the average SAI charge is 1.44 percent per year. This is in addition to the 1.56 percent charged by the average Annual Expense Ratio. In other words, the total charge of the average mutual fund is 3.00 percent per year. If you pay an advisor 1 percent or more per year to manage your assets in what is known as a “wrap account,” you may be paying total annual costs that exceed 4 percent per year. In this down market, the last thing you need is to be hit with layers and layers of fees!
4. All chips on the table all the time
Though I do not recommend market timing (trying to predict short-term stock market movements), I do believe it is prudent to be more cautious or defensive at times. Most mutual funds stay 100% fully invested in the market at all times and do not account for changing economic conditions. The charter of most equity mutual funds requires the fund manager to maintain high exposure to stocks indefinitely. Whether there are good buys available or not, said manager has to keep buying companies knowing full well that the timing may not be right. Worst yet, he may have only 20-25 stocks he feels have good upside yet his charter requires more diversification so he is forced to buy “losers” to spread out risk.
5. One size fits all bad advice
Mutual funds get paid to keep you invested all the time. Marketing materials can be sliced and diced to tell you the story you want to hear. The fact of the matter remains that most mutual funds underperform their respective indices. Good money managers are hard to find yet there are thousands of mutual funds lining up to handle your money.
So where do you go?
It starts with find a team of financial professionals you can trust. If you are a faith-based investor, a great place to start is seeking out a qualified Kingdom Advisor, who specializes in faith-based or biblically responsible investing. There are many faith-based options that can support both your family’s goals and values. Mutual funds aren’t the only game in town. Stocks, bonds, ETFs, real estate, commodities, and gold offer additional choices to diversify your portfolio and help you have a better understanding of exactly what you own.