Are Mutual Funds a Good Investment?

The honest truth….

If you have money in a mutual fund you’re probably paying too much for it!

The problem with mutual funds is that they charge high fees, and are aggressively peddled by banks. Someone looking for financial advice goes to their bank for guidance and are sold the investing equivalent of Beats by Dre, a “premium product” that leans on its brand name to create an illusion of quality.

The problem with mutual funds is that they’re expensive. The fund pays hiring costs, distribution fees, sales and other expenses; it all adds up. The average equity fund has an expense ratio, or mutual fund fee, or 1.3% – 1.5%.

Imagine in 1990,you put your money into a generic mutual fund which mimics the return of the S&P 500 and charges 1.3% in fees. You started with $10,000 and invested it in the U.S. stock market for 25 years.  You were diligent and did what your financial advisor recommended. Let’s call this fund the Charlie Horse Fund.

Now imagine you did the same exact thing with a cheaper mutual fund charging 0.3%. Let’s call this one Magical Unicorn Baby Fund.

What would the difference would be?

By 2016, you’ve paid Charlie Horse Fund $12,000 in fees. Meanwhile you forked over just $2,700 to the Magical Unicorn Baby Fund.

The worst part isn’t the extra $9k you paid out to Charlie Horse. It’s that the money could’ve been earning interest along the way! Over 30 years you gave up on another $9k in earnings, bringing the total cost of owning Charlie Horse over Unicorn Baby to about $18,000.

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If you were making regular contributions every month that whole time, your costs would skyrocket. This was a very simple example following the growth of $10k over 25 years.

What can you do?

The first thing you have to do is pull your money out of mutual funds. Then, you have two options.

Option 1: The DIY route

This is the harder choice. You make more decisions, butalso know exactly what your money is doing. The DIY approach involves creating a portfolio using low-cost online brokers like Schwab or E*Trade.

This way you keep costs incredibly low. You’ll never get rid of fees entirely but you can do your best to minimize them as much as possible. If you just wanted to invest in the overall market you could buy the Schwab U.S. Broad Market ETF (SCHB), which has an expense ratio of just 0.03%.

That blows Magical Unicorn Baby Fund out of the water, with an expense ratio of 0.3%.

If the average mutual fund charges 1.3% just think about how much you could save by investing in such a way that your overall fees drop to 0.03%. At that rate, over 25 years you pay just $300 in fees.

Option 2: Robots

This option involves robots, so obviously you’re going with this one right?

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There are many firms disrupting the traditional financial services model by offering people access to robo-advisors. These online services are easier to use because they restrict the amount of choices you have to make. You don’t have to know anything about investing. It’s a set-it and forget-it method for people who just want to live their lives. You pick what sort of risk tolerance you’re willing to bear and they do the rest. Everything is automated so they cut down on costs and pass on the savings to you. The fees for robo-advisors like Betterment or Wealthfront range from 0.15% to 0.4% at the high end.

At the end of the day you have to make sure you are ruthless when it comes to fees. Get it down to as close to zero as possible and find your own Magical Unicorn Baby.

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