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Value Creation Blog

Why I Don't Use Actively Managed Mutual Funds

Posted by Josh Patrick

Today's video is going to cover why I don't like actively managed mutual funds and you shouldn't either.  After you watch this video, why don't you let me know what you think in the comments section below?

 

 
Basics of Investment Management

Transcript:

Actively managed fund is when a money manager chooses stocks they believe are going to beat the market indexes they are compared to. For example, an actively managed fund might work with the largest five hundred companies in the country. These funds won’t hold all 500, but the managers will try to choose stocks they believe will beat the market.

The problem with this is too often, these managers don’t beat the market and there are a few reasons this happens.

The truth is actively managed funds are great for the fund companies and often not as good for the people who have money invested in them.

Hi, I’m Josh Patrick and I’m the founding principle here at Stage 2 Planning Partners. I want to take a few minutes of your time to talk about why actively managed funds for the most part don’t make sense.

First and most importantly managed funds cost too much money. 

If you were to buy the Vanguard 500 index fund you would pay a management fee of .18%. The average large-cap actively managed fund would run you between 1% and 1.5%. And that’s before trading costs which can run as high as 3% for an actively managed fund.

Is it any wonder that very few actively managed funds beat the index they’re measured against. Many of these funds are starting with a deficit of at least 2.5 to 4% before anything happens.

This means that your actively managed fund manager has to beat the market by 2 to 5% before you get a return that’s better than the market. And, there are very few fund managers that can do this on a consistent basis.

It’s true, very few managed fund managers beat the market.

When you look at the expense ratios of actively managed funds I bet you’re not having a hard time understanding why most actively managed funds rarely beat the benchmark they’re measured against. It seems to me the real winners with actively managed funds are the mutual fund companies themselves and not the investors in the fund.

I bet you’ve seen lots of advertisements for mutual funds that are actively managed and very few advertisements for index funds. Do you ever wonder why that’s true? My guess is because actively managed funds are much more profitable for their owners.

To be fair, according to the Motley fool the average index fund is almost 5 times the size of the average actively managed fund. So, scale has something to do with the cost that you pay to have your money managed. And, because index funds are often much larger than an actively managed fund you get the advantage of that with lower costs.  But, that doesn't explain the cost of trading fees which are never disclosed and eat away much of the gains you get with active management. 

Next, the tax costs of actively managed funds are high.

It’s really hard to have a tax efficient strategy where the average fund buys and sells every fund in their portfolio approximately 3 times per year. This is what your average actively managed mutual fund does.

On the other hand, a passive fund like an index fund only changes stocks when the index changes. This automatically makes an index fund more efficient from a tax managed basis than an actively managed fund.

You might not know this.  Your tax bill gets higher every time your fund manager sells a stock.  This is especially true when they only hold the stock for a few months.  It's one to the reasons I don't like active management.

Here’s something I bet you don’t know - A top tiered fund often ends up doing much less well after their high rating.

If you look at the top rated mutual funds from five years ago very few of them will be a top rated fund today. There is a huge number of funds that do well for year or two and then for a variety of reasons will do much less well and fall out of the top tier.

An index fund doesn’t try to beat the market it just tries to be the market. The reason we like index funds is because research has shown that asset allocation, meaning how much of your money goes into stocks, bonds and cash will shape your return much more than the particular underlying assets in any mutual fund.

So why don’t you do yourself a favor? When you build a portfolio use passive management funds like index funds or Exchange Traded Funds’s. I know passive investing is not nearly as exciting as active management. And, I don’t know about you but I would rather have boring than exciting in my investment portfolio any day. Especially if it has a good chance of beating the high turn over actively managed fund.

Hey, if you’re interested in learning more about investments why don’t you click belowq and get our free special report on how you should look at your investments. I bet you’ll learn something you didn’t know.

This is Josh Patrick and I want to thank you for taking a few minutes to learn about our thoughts on active fund management. I would be happy to talk with you about what we do and all you’re going to have to do is click on the link at the end of this video to set a time to talk.

I hope to see you back here really soon.

 

Topics: Investments, investment management video

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