5 reasons mutual funds may be a bad way to invest your money

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.

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10 Comments
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  1. I always find it amazing when celebrity financial advice people suggest that people simply invest in mutual funds. Your list of issues with them are a good reason that everyone should avoid mutual funds.

    Research shows that most mutual funds don’t beat an index of the S&P500 or their underlying index. And most mutual fund investors lose even more because they jump from hot fund to hot fund and miss the run ups but suffer the pull backs.

    With the advent of ETFs and closed end funds, the choices are much larger. Though I would say that investing in the stock market over the next couple of years is probably going to be a no win situation. You can check out my post http://www.askthewealthsquad.com/blog/stock-market-prediction-year-2009/ to see why.

    I would suggest that starting a sideline business would be more beneficial for people than simply pouring money into the stock market. Diversification doesn’t mean buying 7 different stocks. It means creating non correlated assets to bring in income. Building a small business is a great way to diversify your current stock market investments that are in an IRA or 401k or other tax deferred accounts.

  2. Well I agree 100% with all of these points. I’m a bit amazed to hear anyone still espousing investing in mutual funds – perhaps they just don’t know enough about how ETFs work. But even some ETFs suffer from the problem of being a basket of stocks – e.g., I won’t invest in a broad-based agriculture ETF because I don’t want to give my money to Monsanto, Tyson, or Archer-Daniels-Midland. Yet there are a couple of ag stocks that I feel I can consciously support. So I will buy those stocks separately and on their own.

  3. Scott–Solid advice (investing in a sideline business). In fact I so agree that my own site advances exactly that concept.

    I don’t think this recession will be at all short and we’ll need ways to work through it and even thrive by thinking outside the box.

  4. I’m going to respectfully disagree with the advice in this post.

    Mutual funds are a great way for investors to get started. If investors choose a good no-load fund, with no redemption fees and buy it directly from the fund company, they will generally receive a good long-term return with low expenses. If they are worried about trading costs or the skill of the fund managers, they can invest in index funds, which rarely trade the stocks. Mutual funds are required by law to list fees and the largest stock holdings in their prospectus. So, they are very transparent.

    What the author is recommending instead is that readers go to a qualified Kingdom Advisor, who is almost certainly going to steer them into commission-based products. The author fails to disclose his relationship and/or interest with these Kingdom Advisors, which I believe is important information for readers before investing.

    Another critical issue for readers to understand is that independent investment advisors aren’t normally audited like a mutual fund. This could put their financial future at risk. I’m not aware of a single mutual fund that has stolen all of their investor’s deposits, but some investment advisors have done this and the result is devastating to the investors.

    I have no problem with financial advisors or Christian values. But, I think investment advice should be accurate, unbiased and fully-disclosed. If a reader feels more comfortable with a faith-based advisor, I encourage him or her to do so, with full knowledge of the fees and commissions.

  5. I think mutual funds are a good part of a portfolio, but they shouldn’t make up everything you own. I’ve also become a bit skeptical about some of the track records and fees that many funds are offering these days.

  6. In selecting a fund I think it is wise to look at the morality of the fund manager.

  7. Travis

    I will never understand why people invest in mutual funds with the existence of closed-end funds.

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