Untold Story of Mutual Funds

spooky monster hands

April 8, 2022

I recently reviewed a prospective client’s portfolio, currently being “managed” by another Financial Advisor.  This person who we will call Ted had approximately 17 different mutual funds in his portfolio, and when I gave Ted a review of what he actually owned and paid in fees, let’s just say he was shocked.

Now, mutual funds have been around for a long time and some state that they started in the early 1800s as closed end investment companies.  Investopedia states that Massachusetts Investors commenced the first modern day mutual fund in 1924 today known as MFS.  Mutual funds pool money from investors to invest in stocks, bonds or other securities. Pooling assets can be a great way to cost effectively get diversification for smaller portfolios, and provide access to professional money managers for those who would not otherwise be able to get access to this type of expertise.  On average, most funds allow investments with as little as a few thousand dollars.

What I am finding more and more is that as investors’ portfolios grow, they need to evaluate whether a collection of funds is still the right way to invest.

Overdiversification

Although diversification is a key to a good investment strategy, it can be taken to the extreme and actually do more harm than good.  In Ted’s case as mentioned above, he had so many funds and many in the same sector that I would argue he was overdiversified.  According to a Morningstar report, U.S. equity funds held an average of 171 stocks.  Let’s just assume that 10 of Ted’s funds were equity funds, that’s 1,710 different stock positions, and without knowing exactly what positions each of these funds own, I would be willing to bet that a lot had the same position.  In fact, I’d also be willing to bet that one manager would be selling a position and another manager selling the same position over the life that Ted held these funds.  Apart from not being very efficient, that just causes additional trading costs to hold the same position.

Cost

What you need to be aware of here is if you use an Advisor to select and purchase the fund on your behalf, then it’s more than likely that you’re paying two fees.  Mutual Funds carry an expense fee that can range drastically.  Today it’s possible to get a passive fund (meaning it just mimics an index) very cheaply, however the active funds (meaning they are trying to beat an index) carry an average fee of 1.27% (according to Rebalance IRA).  IN ADDITION, you will also be paying the Advisor for selecting and overseeing the fund.  You can be paying that as a wrap fee (a percentage of your assets) or in what’s called 12B 1 fees, paid by the mutual fund to the advisor.  The 12B 1 fee is a marketing service fee, generally on top of the expense fee to manage the fund.  Get the bottom line figure.  It might not sound like much but take a look at the Morningstar example below:

Know your client.  One of the major things we need to do as Financial Advisors is to Know Your Client.  That’s essential to not only set up your financial plan and select your strategy but ongoing management and maintenance.  Mutual Fund Managers don’t know who you are and will likely never know your specific circumstances.  Specifically, at the end of a good year in the markets a good advisor will be looking at what your taxable portfolio produced in gains/losses throughout the year and at least discuss any potential strategies to assist your overall tax position.  That’s not something a fund manager can do on an individual basis. In fact, turnover in the fund can be increased due to investor requests for cash and that can force the manager to potentially take capital gains and those will be distributed to the shareholders.

How are We Different

We create and manage our client portfolios in-house. These portfolios are built based on research and contain stocks and bonds. I believe this is a superior way to manage client funds. Why?
We have one fee, it’s transparent and I can tell you what’s in the portfolio and why, and should market conditions change what we’re doing about it.
It’s personalized to meet your specific needs. 
The more fees you pay, the more comes out of your pocket. We’d rather leave it in your portfolio than pay it to us or anybody else.

If you’re like Ted, and would like to review what you own and what you pay in fees, don’t hesitate to give us a call.
Mick Graham, CPM®, AIF® Branch Manager Raymond James Financial Advisor Melbourne, FL

Mick Graham, CPM®, AIF®

Branch Manager Raymond James

Financial Advisor Melbourne, FL

Views expressed are the current opinion of the author and are subject to change without notice. Opinions expressed are not necessarily those of Raymond James Financial Services. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance does not guarantee future results.

Investors should consider the investment objectives, risks, and charges and expenses of mutual funds carefully before investing. The prospectus contains this and other information about this investment. The prospectus is available from Mick Graham and should be read carefully before investing.

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