A mutual fund by nature is the pooling of assets from investors into stocks, bonds or other asset classes. It is considered an efficient way for smaller accounts to get diversification and obtain a professional money manager that they otherwise wouldn’t get access to. While they may be a great vehicle for someone to get started in investing or someone in a retirement plan, they have pitfalls that are not as commonly known.
Firstly, and this is what I see quite commonly, is an investor hires a Financial Advisor to manage their money and the Advisor purchase mutual funds. Advisors sometimes decide to use mutual funds to provide their clients exposure to certain types and styles of asset classes (e.g., large cap funds). What you need to understand here is that when an advisor selects a fund for you, there are fees. Mutual funds generally charge a fee or possibly a series of fees depending on the fund, and in addition the Financial Advisor may be compensated in addition to those potential fees. You’ll need to read the fine print.
Diversification is a way that a Certified Portfolio Manager can help reduce risk by purchasing different asset classes and sectors. I have seen accounts from new clients that hold several dozen different mutual funds in a way to diversify but I’m concerned this creates a large amount of crossover. According to Morningstar, on average, U.S. equity mutual funds own 171 stocks, and high net worth investors own between 5 – 10 different funds. Based on these numbers, the investor would have exposure to over 1700 securities. I would argue you end up owning the same security over an over again. I call this over-diversification.
I’ll group the final few points together under the tag of “lack of personalization”. By not considering each client individually, how can one be sure the investments meet specific needs, communicates effectively or be considerate of each client’s individual tax position?
In summary, mutual funds might be a great way to start investing, or in a retirement plan. However, if you have more than $100,000 to invest, there may be a better way.
Source: Morningstar, 06/04/2015.
*This example assumes a $1,000,000 portfolio with an annual return of 10%. The example is provided for illustrative purposes only, doesn’t include transaction cost and is not intended to portray any prior or future performance results. Actual returns will vary. Investing in securities involves the risk of loss.
Mick Graham, CPM®, AIF®
Financial Advisor/Branch Manager Raymond James Melbourne, FL
Views expressed are those of Mick Graham and not necessarily those of Raymond James Financial Services Inc., and are subject to change without notice. Information contained herein was received from sources considered to be reliable, but accuracy is not guaranteed. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Diversification and asset allocation do not ensure a profit or protect against a loss. Past performance is not indicative of future results. No investment strategy can guarantee success. Raymond James is not affiliated with and does not endorse the opinions or services of Morningstar.