First, what is a mutual fund? Well to keep it simple, a mutual fund is essentially a pool of money, collected from a group of people, that is actively managed by, usually a human, and the money is typically invested in many different stocks, sometimes hundreds…

..the first thing to be aware of is something called a conflict of interest…

So the first thing to be aware of is something called a conflict of interest.

Because of the way mutual funds are structured, and how they charge fees means they are much more interested in how much money they can collect to add to the pool of money, than the actual performance of the pool of money.

So what does conflict of interest mean? It means your goals, which should be the growth of your money with low risk of permanent losses, goes against the goals of the mutual fund, which is to collect assets from as many people as possible. And really not pay attention to the performance of the money already under management, only so much as to not fall drastically behind in performance compared to other mutual funds. Doing this also contributes to the chronic underperformance of mutual funds. In investing, it’s crucial to be able to think independently, and if you’re always looking over your shoulder at what other managers are doing, instead of focusing on what you know, you start making poor decisions not based on any real evidence. This is why it’s impossible for mutual funds to act ethically in the interest of their investors, as they claim, even if they’re well meaning, which I know most probably are.

The financial system is the only system that is not performance based, instead managers are paid by how much money they are managing, not the performance of their investments. This is insane. This is what’s known as a zero value added service, because you don’t receive any value for the fees you pay for investing in a mutual fund. Which are typically 1 to 2%. Every year, regardless of performance. Think about that…What if your plumber worked like this, they simply got paid for breathing, and not for actually repairing your pipes. It makes no sense, yet through clever marketing and calculated confusion, the financial industry makes people feel they are incapable of understanding how to invest and what they’re doing is somehow magical…It’s not.

The financial system is the only system that is not performance based…

Let’s talk about Fees. In 2008 alone, Wall Street took in 100 Billion in fees. Think about that for a second, not only did they get crushed and many people lost everything, add insult to injury and they took in more money than ever before.

The average mutual fund charges between a 1-2% MER, management expense ratio, or management fee, which goes to the bank or whoever is running the mutual fund. This 1-2% is based on the total amount of money in the pool, not how well the pool of money performs, and this is the most important thing to remember. What your financial advisor or banker won’t tell you when you’re signing up is that 2% fee means you will be handing over 50-65% of the profits to them, over the course of your life, say 20-40 years. Think about that, what if I came to you with a deal, and said, “okay you put up all the money, take all the risk, but I get 60% of profits!” It’s nuts!

What your financial advisor or banker won’t tell you when you’re signing up, is that 2% fee means you will be handing over 50-65% of the profits to them, over the course of your life…

Now let’s talk Performance. And it has not been good. At all. 99% of mutual funds have underperformed the market since 2006, and history is rife with examples of poor performance. And the wild thing is, they typically underperform by the percentage of their fees, typically 1-2%. So 99% of the time you’re better off investing in a stock market index like SPY. That number still blows me away when I look at it. Think about that, a 99% failure rate across your industry, yet you still took in 100 billion in fees. Try that in any other industry and see what happens. You think McDonald’s survives with a 99% failure rate in getting your order correct?

You think McDonald’s survives with a 99% failure rate in getting your order correct?

Mutual funds are not “safe”, they typically tout themselves as either low risk, medium risk, high risk. This measure of risk is based off of something called the efficient market theory. And in this theory they use something called “Beta” to measure risk. This is crazy, because Beta simply measures how much a stock price goes up and down compared to the stock market as a whole. This is is utterly irrational, because real risk comes from first, not understanding what you’re invested in, and second, it comes overpaying for a business. Because ultimately that is what a stock is, it’s a piece of a real business. Period.

Defining risk by how much the price of something goes up and down is like saying buying that big screen TV on Black Friday is ‘risky’ because the price has moved a lot recently, even though it’s far less ‘risky’ to buy it at half price! How much the price of an asset moves doesn’t define its risk. How much you know about the industry, the management, the cashflow, and how much you paid, is truly what dictates your risk!   

 

The financial industry is set up to confuse and misdirect. All those juicy fees have to go somewhere, and where do they go you might ask? Marketing. Mutual fund companies spend billions on advertising to make you feel comfortable handing them your savings, even though they don’t provide any value. Those fees go towards Superbowl ads, trading costs, big offices, business lunches, kids tuition to private schools, vacation houses, flights, golf, hotels, etc. But none goes to what you think you’re paying for…performance. There is a MASSIVE propaganda campaign to keep you convinced that only they (insert mutual fund here) can get you the desired results. But I couldn’t be more excited to be living in this information age that is quickly levelling the playing field. If we as individual investor are willing to put in the effort to learn the basics, we can do far better, with much less risk! Just by applying the simple principles taught by great investors like Warren Buffett.

 

So I thought I’d share some questions you may want to ask your financial advisor…

  1. How do the fees work? Do I pay fees if my portfolio has lost money? Why is that?
  2. How much of your own money is invested in this fund you’re showing me? (Do they eat their own cooking?)
  3. Warren Buffett says cash is the best thing to hold right now, what happens if the best option for us is to wait and hold cash? Do you still get paid? Or does the money always have to be invested, regardless of how expensive the market or the individual companies are selling for?
  4. Can you invest in any stock, or are there any constraints? (Only oil? Tech? Financial?)
  5. Just out of curiosity, what was the last book on investing that you have read?

Questions like these should give you a pretty clear indication of whether your interests align with theirs.

 

 

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