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INVESTMENT: Why Investors Are Pulling the Plug on Mutual Funds and Why You Should Follow Suit
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Why Investors Are Pulling the Plug on Mutual Funds and Why You Should Follow Suit

By Michael Dow

BT 201603 34 Investment.jpgMutual funds - actively managed pots of money that generally aim to beat the average performance of the stock indexes and protect investors from sudden downturns - have long divided opinion amongst financial commentators. Of course if you listen to the big boys on Wall Street or the Chinese wealth management firms, whose offices are ubiquitous in big Chinese cities nowadays, they will tell you that the best way to make a return on your hard earned cash is to let an expert handle it for you. There may be an element of braggadociousness in there, but the main reason they say is that they want they enjoy counting the juicy profits they make on your management costs.

In times gone by the case for investing in mutual funds was more somewhat more compelling than it is today. One remembers the pre tech bubble and pre 2008 financial crisis eras, during which time dozens of superstar money managers made the average rate of return on the Dow Jones, the S&P 500 and the FTSE 100 look pathetic. Mutual funds were further popularised by a wave of literature on how to beat the market, including legendary Wall Street wizard Peter Lynch's Beating The Street. Eventually most individual investors who were looking for ways to retire in style came to think of this method of investing as being much sexier and much more lucrative than simply buying low cost index funds and playing the waiting game.

BT 201603 35 Investment.jpgA report by Morningstar INC showed that in 2015 American investors alone took a whopping 207.8 billion USD out of their mutual funds. So far this year the trend looks to be continuing strongly. In the last few months, as global equity and commodity prices have taken yet another hammering, there are signs that investors might finally be waking up and smelling the coffee. Data released yesterday by Thompson Reuters Lipper showed that investors around the globe pulled more than 60 billion USD from mutual funds in January alone. The majority of the cash was being taken out of European funds, which accounted for around 47 billion USD worth of withdrawals. According to Amin Rajan, chief executive of Create Research, the consultancy, said: "Investors have become ultra jittery about market contagion. They ran for the hills after the meltdown in Chinese markets at the start of 2016".

Right now it seems that they are terrified of not being able to get out quickly if there is further market volatility, but it might also be the case that some of them have simply lost faith in mutual fund managers and instead they are increasingly taking matters into their own hands. Sarah Krouse of the Wall Street Journal points out that "The shifts are the latest evidence of a sea change in the asset-management business in which investors are increasingly opting for products that track the market rather than relying on managers to pick winners". Ironically, she says, this is also happening at a time when money managers on the whole have been doing pretty well against the average returns of the financial markets.

It is hard to say what exactly is driving the current mass exodus from mutual funds. What isn't difficult to argue though is that investors are usually much better off in the long term if they take a more passive approach to investing. According to one study carried out in the United States, which looked at the performance of 355 investment funds from 1970 to 2005, after deducting the expenses only 9% of these money managers produced a return that was more than 2% higher than main benchmark indexes like the Dow Jones or the S&P 500. Obviously the employees at your stockbrokerage or your mutual fund manager would like you to ignore this cold hard reality, but it is simply a fact that individuals and institutional investors alike rarely do better in the long term than lazy, passive investors who put their cash into index funds.

BT 201603 32 Investment
The main reason why so many people shy away from this boring but highly effective methodology is that it requires a fundamental change of mind set towards investing. It requires people to ignore the hype about individual companies and all-knowing money managers being able to consistently beat the market on their behalf. In order to do that they need to break the habit of thinking about getting rich quickly by day trading and instead simply letting their money, the markets and compounding dividend yields do the work for them. As Warren Buffett, the greatest investor of all time explains: "the average individual investor who consistently saves over the course of their lifetime should just consistently buy low cost index funds and they will do very well over time". Moreover, he points out that "the last thing they should be doing is buying and selling stocks... they are simply not in that game and they should not be tricked into thinking that someone can tell them when to trade stocks".

As the old saying goes, good things come to those who wait. And when it comes to sensible long term investing, big money also comes to those who manage to keep their expenses down. The best way to do that of course is to avoid paying hefty annual charges on mutual funds and instead opt for some of the very low cost ETFs and index funds. That way we can get much more bang for our buck and far fewer headaches when the proverbial hits the fan from time to time.


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