When I first started looking into a career in the financial planning industry several years ago, mutual funds had just become the “cure-all” investment product. I was investing in them. My dad was investing in them. My boss, my broker — everyone, it seemed, had come to realize the benefits of owning mutual funds.
By the time I made the transition to the industry, mutual funds had become old hat. Clients had become familiar with the concept, and they did not need to be sold on the idea.
Everyone knew about the benefits of dollar cost averaging and load vs. no-load funds. They had gotten to the point where they wanted to know which ones were going to outperform each year.
The new mantra when it came to mutual funds had become: “Here is the money, now go invest it.”
A Great Idea
Indeed the mutual fund industry has cornered the market on a valuable investment idea: Namely, invest in a diversified portfolio of stocks by pooling your money together with other like-minded investors. In addition, you pay a relatively small fee to do it, compared to what you would pay if you were to assemble a similar portfolio on your own.
The concept started more than 75 years ago with the Massachusetts Investors Trust Fund, and has nearly everyone, from the beginning investor to the more sophisticated investor, believing that he or she should own mutual funds — not just to lower fees, but also to reduce risk.
There are now more than 10,000 mutual funds to choose from, in an industry where fewer than 1,000 existed 20 years ago. All of these funds want your investment dollar. They advertise directly to consumers in such places as Money magazine, bragging about the number of stars they earned from Morningstar last year, last quarter, or even last week. Need an IRA, open a mutual fund. Want to invest for college, open a mutual fund. Your company needs a 401(k)… great, I have the best mutual funds.
For many people, mutual funds are a great investment. If you are just starting out, or want to invest a specific dollar amount each month, mutual funds can be the way to go. But be sure you take a close look at your specific situation and goals before jumping on the bandwagon.
Don’t Follow The Herd
There is a saying that goes something like this: “Following the herd is a sure way to mediocrity.” What does this mean?
While the mutual fund industry is serving a larger and growing clientele, and more and more people become invested in the stock market in this way, the competition to beat the market average and to lure investors away from other fund companies has become a rat race. With increased marketing comes higher fees.
With more fierce competition, many firms strive to separate themselves from the pack; and by wanting to separate from the pack, the manager must take on more risk. With more risk comes the possible “grand prize” of beating all other mutual finds for the year — along with the more likely scenario that your mutual fund will give you a rate of return that is less than pleasing.
Ironically, the reason most people invest in mutual funds is to lower fees and reduce risk. Many fund companies are becoming so competitive, that just the opposite is occurring.
Private Money Management
Although mutual funds may be the darling of the popular press, they aren’t the only way to invest with reduced risk and lower fees. The sophisticated investor and investment advisor have long known about private money managers and successful investment strategies. They have just been lost in the commotion over fees and mutual funds during the past 10 years.
Does it make sense for a chiropractor who is putting away $30,000 in pre-tax income to be using a retail product? How about a doctor who has just sold his or her practice and needs to place the proceeds in a diversified portfolio? Is a retail product that’s said to cater to both the beginning and astute investor the best option? My opinion is no.
A retail mutual fund is a good starting point, but it is not the end-point. Remember that mutual funds today are marketed to everyone under the sun. Chances are, your comfortable level of risk may be very different from that of your mutual fund manager.
By contrast, an able investment advisor can assemble a private money management team, whereby the manager buys the stocks for you in your own privately held account. You actually own the individual stocks. This is in contrast to a mutual fund, where you own shares of the fund.
Your private money manager knows your risk tolerance, what you are saving for, and your desire to avoid capital gains. The mutual fund manager does not know this, nor does he or she care. This is not a criticism of mutual fund managers as individuals, mind you. They are a blind third party in the transaction. A reliable advisor can help you invest the money or put you into the hands of a more capable element, if he or she is not comfortable picking stocks.
Who Can Benefit
What does private money management have to offer?
- Your level of risk and your goals are taken into consideration. If you are saving for your child’s education five years from now, investing in some high-flying IPO isn’t what you are looking for.
- The customization of your account is far superior to that of a portfolio of mutual funds. And style drift is essentially eliminated.
- You own shares in each company, not shares in a mutual fund with other investors who are free to sell in a market panic and bring the price per share of the mutual fund down.
- There are no 12b-1 fees or sales loads to calculate. You have an investment management fee and the custodial fee, which are often less than what the retail mutual fund charges.
- You have access to the best private money managers. Are the top money managers at retail mutual funds? Usually not. The best money managers don’t have to advertise their services. We come to them.
- Portability. If you dislike your money manager, you fire him or her, take your shares of stock and transfer them to your own account. If you dislike your mutual fund manager, you sell your shares back to the company, calculate any deferred sales fee that you may be charged, pay taxes on your gain, and then open up another mutual fund account with another retail firm.
Why else are private managers better for the sophisticated investor? Taxes. In a private managed account, you control the capital gains by deciding when to sell. If you do not sell, you do not face any capital gains. So, you control the tax consequences in the account. It’s a tax-efficient method of investing.
Mutual funds, on the other hand, distribute capital gains each year to their investors. So, on top of the expense fee, 12b-1 fee, management fee, and possible commission you have to pay, you get hit again each December when the fund distributes capital gains.
Who are some of the investors who are most likely to benefit from private money management? Chiropractors, dentists, and medical doctors with their own businesses that funnel a large amount of pre-tax dollars into retirement plans and other savings vehicles. Investors who are looking for tax-conscious investment management or socially responsible investing. Affluent individuals with different needs than the average investor. And those seeking to avoid mediocrity by distancing themselves from the herd.
