I recently took a "personal finance" course. We spent a week talking about stocks; two weeks talking about mutual funds; and the equivalent of one day on real estate. Suffice it to say, the book made mutual funds out to be a pretty sweet deal. It's a crying shame that I know better. What follows is my rant on the class message board shortly after the conclusion of class. Enjoy!
In his books "One Up On Wall Street" and "Beating The Street", the great Investor Peter Lynch admitted that a mutual fund is basically flawed, but for different reasons that you might expect. Let me give you an example.
The fundamental flaw of mutual funds
Two rich guys are playing golf, and they talk about how their mutual funds are doing. Mr. A brags that he made $20,000 last month. Mr. B, however, only made $10,000. The trouble is: they have the same mutual fund manager. Different funds, same manager. The first thing that Mr. B does is call the broker. He demands satisfaction. The broker carefully explains that while his is under-performing right now it will-- "NO!" shouts Mr. B , "I want to be making as much as Mr. A!" So the broker does what Mr. B wants and buys the same thing for both Mr. A and Mr. B.
The problem is: ALL of the managers do this. Why? Because every time they make a decision, they have 60 phone calls from people asking why. If something isn't doing as well as another fund, there are more phone calls. So very, very many phone calls. Mr. Lynch states that a very large portion of a manager's time is spent merely explaining the decisions that they've made. In order to keep from going insane, the mutual fund manager acts like an exhausted mother: "Alright, everyone gets one cookie!" That is, instead of everyone getting something different, they all get the same, "safe" investments that most of the other managers are buying for their clients.
What does this mean? It means that mutual funds are a lot more similar than anyone is willing to admit. This also makes them FAR more susceptible to panics (which LOSE you money) since all the eggs are in essentially the same basket.
The experts are not even very good
The "experts" don't do as well as the charts would have you believe. I would like to direct you all to this little number, studying the The "Dartboard" Column of the Wall Street Journal, that pits the "experts" against throwing darts to pick stocks:
Stock Dartboard. Here is an excerpt from the Abstract:
"...abnormal returns and trading volumes following the announcement date are driven by noise trading from naive investors. The bootstrapping results indicate that the performance of the pros' stocks is indistinguishable from that of the dartboard stocks for 90% of the contests. Overall, pros can neither outperform the darts nor the market."
Huh, so the professional mutual fund managers, the ones that you are paying to invest your money for you, can be bested by throwing darts. Good to know.
Mutual funds are just so hard to understand
Lastly, there's the fact that you need a Master's degree in mathematics to understand this stuff. Unless, of course, you want to be one of those "naive investors" who ends up actually losing rather than making money. Beta? Alpha? R-squared? Moving average? Yikes. How are you supposed to pick a good mutual fund? From the charts? Statistics? Does doing better than the industry necessarily mean that you're getting a good return on your money? (Hint: no). Should you go with Large-Value? Small-Growth? Aaaaah!
So what is a good place to put your money? Well, I might be a little biased, but I think real estate is a pretty darn good vehicle. Sure, it may hard work, but you don't have to be the one doing the work.
