I had an interesting call the other day. Not gonna lie, it kind of stopped me in my tracks.
It was an investor, someone who has been following American Wealth Builders for a while. They own a portfolio of stocks, and they’re thinking about getting into real estate.
They said something that caught me off-guard.
After I thought about it for a while, I sat down and wrote this email. It will probably get under his skin (and yours) but I have to say it…
The conversation went like this:
He said, “Dan, you talk a lot about the problem of individual stocks and how investing in basket of stocks might not always be the best choice for someone’s portfolio.”
Me: “Yes…” (wondering what he’s getting to)
Him: “Okay, I understand how my inexperience can lead to a poor choice of stock purchases. But what about mutual funds? They’re a diversified basket of stocks and bonds selected by a full-time professional manager who is incentivized to make smart picks. So doesn’t it make sense to put my money there?”
I didn’t have a great answer for him that day. It’s true that I rail against stocks themselves but maybe less-so against funds. Totally unintentional. So let me fix that today. 🙂
Does it make more sense to invest in mutual funds?
Fund advertisers will tell you that you get a bunch of benefits from funds that you don’t get from individual stocks. The benefits you hear most often are: diversification and professional management. (Yes there are others but those are two of the biggest.)
Problem is, I believe both of these are painfully misleading.
Diversification: You can never fully diversify away all of your risk. There are SOME risks that are addressed with diversification but not all risks are addressed this way. What’s more, even the risks that can be addressed through diversification can only be addressed to a certain extent, depending on the diversification level of the fund.
For example, if the fund you love is heavy into blue-chip American stocks, it might be diversified across multiple industries to protect against any one industry going down… BUT… what if the American economy tanks? Or maybe you have a fund that invests in Pacific Rim companies, including companies that run correlated AND reverse correlated to the economic health of the Pacific Rim. Wow, sounds great, right? Well, that will only be great as long as those Pacific Rim companies continue with their international trade agreements, and as long as the American dollar maintains its position against those Pacific Rim currencies. If Trump renegotiates trade agreements, or if another tsunami hits Japan, or if China stumbles further, or any other hard-to-foresee situation occurs… then that can’t be addressed through the diversification of that specific fund.
Professional Management: Another huge benefit is the professional management that you get in a fund. In theory, you’ve got these Alpha dogs who work full-time in the fund to manage the balance of the fund. Problem is, everyone things these fund managers are working some kind of weird black magic behind the curtain, but that’s not what happens. They have algorithms and alerts and staff that bring them ideas and these fund managers make the final decision…
BUT… fund managers are far from perfect.
The Economist reported that only 25% of US large cap funds beat the market. That’s one of several reports that I’ve seen with similar findings.
But their compensation isn’t necessarily tied to their own success. Many fund managers receive a salary plus a bonus for the amount of assets they have under management, plus they get a bonus for the performance of their fund. Fund managers can make hundreds of thousands, and even MILLIONS of dollars. (Here’s a nice, simple overview from Investopedia.)
Now, I have no problem if people make money for their performance (I wish that was the case for more people, including government workers, right?!) but the money managers make can severely impact your bottom line. If your fund returns 8% (which is pretty average right now, according to CNN) then you may not see that full 8%. You might see a much smaller percentage because of fees that go to the mutual fund and the manager.
And if that’s not frustrating enough, check out this very informative article in Fox Business about how misleading the average annual rates of return can be in mutual funds.
Do you see why I don’t like mutual funds?
The one thing they’re supposed to solve (risk through diversification) can’t actually be solved, and the one strength they promise over the average investor costs a lot of money.
So, do you want to keep your money in a costly fund that might earn you 8% (probably less) and is still at risk to a bunch of areas it can’t protect from?
Or, do you want to put your money into an investment like turnkey real estate that is just as passive as a mutual fund but can return 12%-15%, sometimes more, and is protected because it’s a hard asset?
That’s an easy answer in my opinion. And the fact that I’m real estate investing should tell you exactly what I think that answer should be. If you want to create a higher yield in your portfolio and avoid the crazy fees and insane risk of stocks and funds, get on the phone and let’s talk about what a turnkey property can look like in your portfolio.
Senior Wealth Strategist
American Wealth Builders
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