According to Wikipedia, the first modern investment funds, the forerunner of what is now known as mutual fund, was established in the Dutch Republic between 1772 to 1773.
It was a response to the financial crisis back then and the brainchild of Amsterdam-based businessman Abraham (or Adriaan) Van Ketwich. He formed a trust with the name Eendragt Maakt Magt (meaning – Unity Creates Strength).
Abraham’s main goal was to provide small investors with the opportunity to diversify their portfolios.
Similar examples followed in different countries after that. For instance, in Switzerland, they launched an investment trust in 1849, while the Scottish formed a similar vehicle in the 1880s.
However, the idea of pooling funds and spreading risk using closed-end investment didn’t find its way to the U.S. until around the 1890s. The Boston Personal Property Trust was formed in 1893 as the first closed-end fund in the U.S.
As the name suggests, the investments were primarily in the real estate sector. That is what you call hedge funds today instead of mutual funds.
The Alexander Fund, created in 1907 in Philadelphia, was crucial to what we now have as the modern-day mutual fund. The fund allowed investors to make withdrawals on demand and featured semi-annual issues.
The Evolution of Mutual Funds
According to Bianco Research, the establishment of the Massachusetts Investors’ Trust in 1924 in Boston sparked the arrival of modern mutual funds. Investors had access to the fund in 1928 and eventually producing the mutual fund company known as MFS Investment Management. State Street Investors’ Trust was the custodian of the Massachusetts Investors’ Trust.
1929 saw the arrival of the Wellington Fund as the first mutual fund to feature stocks and bonds. The Vanguard Wellington Fun, still in existence today, claims to be America’s oldest balanced fund.
This blog contains multiple interesting topics about mutual funds, which I think you will find helpful. See the list below:
- What is a mutual fund, and how does it work?
- How many mutual funds should I have? What is the right number?
- How to analyze mutual funds
- What is an open-ended and closed-ended mutual fund?
- Can a mutual fund go bankrupt?
- Difference between growth and dividend mutual funds
Why Mutual Funds Are Bad
As we can see, Mutual funds have been around for centuries, but there are arguments back and forth amongst experts that mutual funds are bad investments. As usual, my role here is not to pick a side but to offer some education to help you arrive at the best decision for your investment journey. Also, I hope to answer a few frequently asked questions. Let’s get into it.
Mutual funds are very popular investment vehicles, especially with Americans. Perhaps the best place to start is to review the pros and cons before concluding if it’s a bad or good investment.
Given the alternative investment vehicles like ETF’s and Index funds, mutual funds might not be excellent investments. Mutual funds cost more when compared with other investments. Moreover, we are in the age of frugality.
Also, if you are a buy-and-hold investor, you might be better off with ETFs because they are cheaper.
Advantages of Mutual Funds
1. Professional Management
If you are new to investment and extra income talks, mutual funds might be the best and safest place to start.
You will not have to bother about buying and selling securities at the right time or balancing your portfolio. There are fund managers who have the expertise to handle all that for you.
2. Easy Diversification
Often you hear about diversifying your portfolio or mixing up your investment, but you are confused about how to go about it. Mutual funds take care of this easily.
If you want to plan diversification on your own outside mutual funds, you may need to spend a lot buying dozens of different stocks and bonds. However, with mutual funds, you can diversify your portfolio among hundreds of securities.
3. Multiple Options
There are loads of mutual funds out there with different objectives. You will most likely find a fund that fits your investment needs.
4. Liquidity
Mutual funds are known to be very liquid investments. You can buy and sell shares in mutual funds any time of the day if you need quick cash.
5. Low Cost
Mutual funds are one of the lowest-cost strategies to invest in large portfolio securities compared to what you would pay in commission if you plan to build a similar portfolio. A lot of mutual funds charge low fees and minimum balance requirements.
6. Dividend Reinvestment
When dividends and other interest income sources are declared for the fund, you can use them to increase your stake by buying more shares in the fund, thereby gradually growing your investment.
Disadvantages of Mutual Funds
Below are some of the reasons why mutual funds are considered bad investments.
1. Load Charges
Different mutual funds have separate classes of shares that come with front or back-end loads, representing fees imposed on the investors when buying or selling their shares. Some loads go from 2% to as high as 4%.
They end up eating into the returns generated by mutual funds. Charges like these make mutual funds unattractive to investors who wish to trade their shares and potential investors.
2. High sales Charges and Expense Ratios
Investing in mutual funds requires keeping an eye on the expense ratios and sales charges because they can eat up your returns and, in some cases, your investments.
When your expense ratio starts to go over 1.20%, you need to be careful because they are considered a higher cost.
Additionally, you need to be conscious of the 12b-1 advertising fees and sales charges, so they don’t eat up the return on your investment. You can look for those funds that have no sales charges.
3. Management Abuses
Your fund manager may abuse their authority by chunning, turnover, and window dressing. This can be in the form of unnecessary trading, excessive replacement, and selling the losers before the end of the quarter to balance the books.
4. Capital Gains
Mutual funds attract capital gains taxes on all shares you sell at a profit. You have no say over capital gains tax when you receive a payout from mutual funds.
Due to gains, redemptions, turnover, and losses in your securities in the year, you receive distributions from your mutual funds that are subject to tax, and you have no control over them.
With other investments, you can control when you sell them. That way, you might control when you owe the taxes, but with mutual funds, they need to distribute the capital gain they have earned regularly. It makes it challenging to use tax strategies like tax-loss harvesting.
5. Cash Reserve
Mutual funds have to keep a certain percentage of their holding in cash form to facilitate the sale of shares by investors to make cash available to them and accommodate new investors.
These reserves are not working for the investors; they are mostly lying dormant. Compared with other investments where your fund is being put to use 100%.
6. Zero Control Over Your Portfolio
When you invest in mutual funds, you transfer all control over to the fund manager and rely on their judgment and experience. You lose the power to decide which stock or sector you want to invest in except where the fund focuses on a particular economic sector.
7. Active Funds Are Expensive
While it is true that there are many mutual funds out there with low cost, actively managed funds are not particularly cheap. These high fees will eventually eat into the return on your investment.
Another way to approach this issue is to compare mutual funds with some of your favorite investment vehicles and allow you to be the judge.
Real Estate Investment Property Vs. Mutual Funds
When you invest in mutual funds, you are investing in a basket of stocks, bonds, or other securities with the hope of getting the best return on your investments. Mutual fund managers manage the investors’ money on their behalf.
A mutual fund is a go-to option for new investors and those who are not well informed about financial instruments and investment strategies. With the Systemic Investment Plan (SIP), mutual funds will help you save and grow your investment for higher returns over a long time.
Also, when you invest in real estate investment property, you invest in rental property, a property developed for commercial purposes, home flipping, and others, also for return on your investment.
It is property bought and developed with the sole purpose of selling or collecting rents as returns. You can begin with a small property like a single unit or an apartment. It all depends on the size of your capital and the investment you are willing to make.
The crucial point is that you can estimate your returns on investment at the end of the day.
The truth is they both offer convincing arguments with assumptions and examples and time frames. Both investment options have pros and cons, even as your hope to get the best return on your investments.
Difference Between Real Estate Investment Property and Mutual Funds
| Criteria | Investment Property | Mutual Funds |
| Risk Factor | When compared with mutual funds, there are fewer risks associated with investment real estate. For the most part, you will be concerned about getting full occupancy for your property, delayed rents, a fall in the property’s value. It is uncommon to experience something like a natural disaster that will wreck your investment. | Mutual funds invest your money in the stock market. The returns depend on Sensex and other economic and market forces. Also, mutual funds can be unstable, making it difficult to predict your returns. It’s common for managers to warn you that historical results can’t be used to predict future outcomes. Things can get unstable in the stock market, and mutual funds will be affected too. Depending on the manager’s experience and the type of fund, you could lose your investments. |
| Control | Immediately your rental property is fully paid for; you have complete control over it. You get to decide the type of development or renovation you want to carry out, your rental income, the sale value, and the kind of tenant you want. | With mutual funds, you have zero control over the manager’s decision and where you want them to invest. You have no power and no say. |
| Investment Size | The investment property investment is huge and often requires debt financing to pay for the property. The size ranges from thousands to hundreds of thousands of dollars to buy a property you can use for office or residential rental property. | Investment in mutual funds doesn’t require a substantial lump sum. To grow your investment over a long time, you need to invest regularly in the form of regular SIPs. |
| Diversification | Despite the large size of the capital invested in investment property, it is not diversified. You are stuck with the property and the risk that comes with it. | Except for special funds, mutual funds investments are the definition of diversification. The fund managers invest in various securities with different risk ranges to get the best returns for you. |
| Liquidity | It takes time to convert your rents or property sale to cash. If you plan to sell the property, it can take weeks to several months to get a good deal. The same applies to getting a good tenant or getting rents from existing tenants. | Investment in mutual funds offers better liquidity. You can sell all or part of your shares in the fund and have your cash between a few hours to days. That’s possible because the fund also keeps cash reserves to cater to these types of requests. |
| Hedge Against Inflation | As inflation and the cost of living rise, rental properties automatically go up too. As an investment property owner, you can raise your rent and the price of your property too. The beauty of this is that inflation doesn’t impact your mortgage. It remains the same. | The scenario is different when it comes to mutual funds. The value of your mutual fund portfolio could rise over time, but they are not linked to inflation as we have in property real estate. |
| Cash Flow | Rental income from investment property guarantees you a steady source of cash. | A lot of the income on mutual funds is on paper or virtual. You need to sell your stake before you see the real money. |
Bitcoin Vs. Mutual Funds
Since its inception in 2009, Bitcoin and other cryptocurrencies have become a sensation to the world. If you invested $100 in bitcoin in 2009, your investment would probably be valued at millions of dollars today.
That is mind-boggling, right? No other financial asset has managed to generate 1/10th of what bitcoin has generated in the past decade. Bitcoins are currently the best-performing financial assets in our world today.
However, the governing laws and guidelines for investing in bitcoin contrast with that of mutual funds. Hence the need for us to compare bitcoin with mutual funds and allow you to make your choice.
Bitcoin Vs. Mutual Funds: Which is Better?
| Criteria | Bitcoins | Mutual Funds |
| Basics | Bitcoin is a peer-to-peer digital currency that allows users to send money over the internet at a fraction of the cost compared to what the local banks charges. | A mutual fund is a pool of funds from several investors invested in debt securities and equities or both. Mutual funds are professionally managed investment vehicles. |
| Valuations | They are a great store of value There are fraud and counterfeit-resistant. Value is driven by demand and supply. Bitcoins and other digital currencies are purely electronic, unlike Gold, Silver, and the Dollar. | Mutual funds are based on Net Annual Value (NAV). NAV is the value of your assets/securities less the outstanding liabilities. The NAV is updated every day after the market closes. |
| Legality | Bitcoins are legal but not yet accepted and recognized by all governments. | Mutual funds are legal and governed by government regulatory bodies. |
| Taxes | There are no specific tax laws for bitcoin investments. However, existing investment laws can apply. Gains may be taxed as capital gains, business income, or professional income. | Capital gains tax and other taxes by the regulating bodies apply to profits from mutual funds. |
| Cost Involved | Investing cost is minimal No other known expenses | Annual expense ratios, Sales loads, short-term redemption fees, and transaction fees. ETFs trade like stocks and attract trade commissions when bought or sold. |
| Trading Times | The market operates 24/7 | Time-bound trading times. Activities stop when the market closes at the end of the day. |
| Risk | Bitcoins are highly volatile and categorized as high-risk investments. | Mutual funds are in the lower category of risky investments. |
| Mode of Investing | You can buy bitcoin from a crypto-broker or crypto exchanges electronically. | You can invest in mutual funds through the online platform of the fund or by visiting the mutual fund office physically. |
| Ease of Investment | You can invest in bitcoin within minutes. However, you need to understand blockchain, mining, and other terminologies to understand how your investment works. | Investment in mutual funds is simple, but some documentation may be required. Also, the fund manager handles everything about your investment. |
Mutual Funds Are Not The Best Investment
It will be difficult to declare mutual funds as bad; that will not be correct. It’s just that they are not among the top investment products available in the market.
Also, one can’t say mutual funds don’t provide any benefits; they are typically index funds that diversify your portfolio. They give you access to various stocks at a lower cost than if you were going to buy those shares individually.
It is better to invest in mutual funds than not have any form of investment. Mutual funds still offer you a lot more than the standard savings account, but that’s basically where it ends.
The Flaws of Mutual Funds
Mutual funds are bedeviled by features that lead to underperformance like active management, high fees, and dormant cash reserves. For instance, because these funds are actively managed, the managers decide what to buy or sell at any time.
Each time they make trades, you are charged a trading commission, and these charges eat into your portfolio.
Also, you are already being charged for active trading, which is already eating into your portfolio. You will still be charged management fees and other administrative fees. It’s sad that even when your portfolio or the manager underperforms and returns a negative outcome, you still get to pay these fees.
Mutual funds are not particularly great for retirement planning
Some funds charge up to 3% in management fees. While this may not look like a lot of money initially, you will be surprised at how much is taken from your portfolio over a long period.
For example, if you have a retirement mutual fund with a deposit of $5,000 and you contribute $500 to the account every month. Let’s say for the next 35 years, and your average return is 10%.
Using the mutual funds calculator, your portfolio should look like this;
Gross ending value = 1,929, 273.02
Cost of fees @3% = $988,409.35
Net Ending Value = $940,863.67
Even if you find a fund with a 1% management fee, you will still pay a lot when you reach retirement age. Let’s see what the figures look like;
Gross ending value = $1,929,273.02
Cost of fees @1% = $416,454.84
Net Ending Value = $1,512,818.18
Important Notice: This calculator presumes you are shopping only for no-load, no-transaction-fee funds. These are mutual funds that don’t charge a sales commission or fees for the purchase or sale of shares.
Analyzing the Calculation
From the first example with a 3% expense ratio, your portfolio could grow to nearly $2 million, but even at the same time, you would have paid more than 51% of that as management fees. Even in the second example, we dropped the fund expense ratio to 1%; you will still pay more than 21% of your total investment as fees.
Any investment planning with an expense ratio of more than 0.50% is considered too high. From the example above, 0.50% will give us $221,577.66.
This is a fair commission for a retirement account and not a situation where you would have forfeited more than 50% of your portfolio to the fund as commissions and other fees.
Bottom Line
You can say mutual funds are relatively safe and low risk. I will say it’s best for beginners and investors with low financial literacy, investors who are still learning the ropes.
You would start to consider mutual funds as a bad investment when you factor in the negative features of the investment vehicle.
As your portfolio grows, you tend to pay more in fees and taxes. These will impact the growth of your portfolio and the returns on your investment.
All the fees that come with mutual funds and the tax implication are not cheap; they seriously affect your investment. There are alternative inexpensive investment vehicles out there that will not eat up your portfolio. You only need to know where and how to look.
