Is Diversification Always a Good Thing?
Millions of people think that investing in a diversified portfolio of mutual funds for a long period of time is the wisest thing to do financially. In my opinion, mutual funds rank as one of the worst financial choices for those who want to build and grow wealth. The biggest problems with most mutual funds are the lack of ability to know what you own and the high-level of fees. Even when you think you are paying 1 percent a year, you may be shocked to know that the fees you are paying actually exceed 4 percent.
Over time, this can be thousands or even millions of dollars. The longer you invest in mutual funds, the more you pay in fees. So how does 1 percent become 4 percent? If you look at the fixed expenses of a mutual fund, they are included in what is known as the Annual Expense Ratio (found online or in the fund's prospectus). Every mutual fund and exchange-traded fund (ETF) charges this fee. No-load funds (no commissions when you buy or sell shares) still charge annual fees.
The Mighty Expense Ratio
The expense ratio pays for the fund's recurring operating costs (such as salaries, research costs, technology, and service, to name a few), but it does not cover trading and other costs. Morningstar, the leading independent third-party mutual fund rating company lists the average expense ratio as 1.56 percent per year.
Hidden Fees?
What is not listed in the expense ratio are variable costs. The biggest variable costs are brokerage commissions and trading expenses. Whenever the fund manager buys or sells a security, he pays brokerage commissions— just as you would if you were to buy or sell a stock or bond. Typically, funds spend tens of millions of dollars in trading costs per year, and these expenses are not included in the Annual Expense Ratio or even disclosed in the prospectus.
To find these and other expenses, you must look in the fund's Statement of Additional Information (SAI). These additional expenses are difficult to determine, but a 2007 analysis by Virginia Tech, the University of Virginia and Boston College revealed that the average SAI charge is 1.44 percent per year. This is in addition to the 1.56 percent charged by the average Annual Expense Ratio. In other words, the total charge of the average mutual fund is 3.00 percent per year. If you pay an advisor 1 percent or more per year to manage your assets in what is known as a ―wrap or fee-based account, you may be paying total annual costs that exceed 4 percent per year.
Here's Why Wealth is Thrown Down the Toilet
Why would I want to pay over 4% per year and not know where I'm investing? That 4% per year is wiping out wealth and I have no clue where my money is being invested. I could choose low-cost index funds or ETFs (exchange traded funds) that mimic a stock market index. However, as an investor who cares not only about how much profit I make, but how I derive my profits, many companies within these indexes violate my personal values and morals. I don't want to profit from companies in industries that don't line up with my beliefs. That is why I purchase individual companies that I can get to know inside and out. That way there I know what I own and can closely monitor their activities.
Handing your money over to someone else expecting them to get you a good return and not know where you're investing is gambling. How is this any different? It's like playing Russian Roulette. You go to a casino put it all on red and hope for the best? Investing is very similar for many people. They invest in mutual funds or hand their money over to complete strangers hoping for the best. At the very least make a commitment to discover where you're investing and how much you're paying in fees. This may be an eye-opening experience. I encourage you to develop an investment strategy based on selecting strong companies that line up with your values.
Some sites to get you started
Here are a few sites to help you learn more about investing. Based on over 16 years of experience and personal usage of the following tools and research, I can confidently recommend the following sites for financial research. For moral and social research, please take check out www.faithbasedinvestor.com. Some of this financial research is free while more in-depth research will entail monthly or annual fees:
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.
