If you have your retirement money in a mutual fund you probably don’t know the real cost. When you find out how much of your profit is going to fund overhead you may want to simply pick your own stocks and bonds to invest in. First let’s look at the cost of a mutual fund and then look at an investor’s guide to choosing stocks and bonds.
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Hidden Cost of Mutual Funds
Forbes published an insightful article about the real cost of owning a mutual fund.
In over 25 years of business, our firm has never had an initial meeting with an investor who completely understood the total costs of the mutual funds they owned. The following article seeks to simplify the many complexities of mutual fund expenses so investors are able to discover the true costs associated with mutual fund ownership. To simplify this topic, six different costs will be evaluated: expense ratio, transaction costs (brokerage commissions, market impact cost, and spread cost), tax costs, cash drag, soft dollar cost and advisory fees.
Most investors are only aware of the expense ratio which is an ongoing yearly charge of about 0.9% to pay marketing costs, distribution costs and management fees. Addition costs of a mutual fund include transaction fees at about 1.44% per year. Then there are tax costs or about 1.2% a year and the cash drag of cash held to maintain fund liquidity at about 0.83% a year. A soft dollar cost hide expenses but costs you money and advisory fees can run from 0.25% to 2.5%. The total cost of having a mutual fund invest your money comes to about 3% in a non-taxed account and about 4% in a taxed account. In our article, When to Start Investing in Stocks, we noted that a 7% per year appreciation can be expected with solid stocks and long term investing. If you are investing via a mutual fund you can cut that in half. So, what is your alternative?
Picking Your Own Investments
US News looks a choosing stocks and bonds instead of going with a mutual fund.
A couple of generations ago investing in stocks meant buying shares of a big-name company like Ma Bell, keeping them forever and enjoying dividend income along the way. But the boom in mutual funds in recent decades has created legions of investors who’ve never owned an individual stock. Are they missing something?
In some respects, it’s easier to trade individual stocks now than in the good old days. A trade that once cost hundreds of dollars in commissions can be done online with a deep discount broker for $5 or $10. You can track prices, do research and place orders on your laptop, tablet or cellphone.
They quote the legendary fund manage Peter Lynch as saying that you need to be able to invest for at least three to ten years and have the math skills of a fourth grader to be successful in stocks. The advantages of picking your own stocks is that you get all or the gains with a winner. You have control over your investments. And you can respond quickly when opportunities arise. Also you will not be paying capital gains on stocks being bought and sold by a mutual fund if you simply buy and hold a set of well-chosen stocks. If you want to broad based investments seen in a mutual fund with a lot more transparency, consider an exchange traded fund.
Another useful approach to finding new and trending investments is using alternative data in finance. For example, Google searches for stock names have positive correlation with stock price movement the following week!