April 21, 2008, 6:00 am

The Real Benefit From Mutual Funds

by: The Financial Blogger    Category: Investment, Market and Risk
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Here is a tricky question; why would you buy something that is a pale copy of an original? Worst than that, why would you bother buying something that is obviously less performing and more expensive than an original? Well this is exactly what you are doing when you are purchasing mutual funds. Wait a minute… I do own mutual funds in my portfolio! Am I making a fool of myself and am I making sense? You need to read till the end of this post to find out!


Mutual funds are copycats

By definition, a mutual funds is a pool of stocks and other investment products that tries to replicate a specific market. So the questions that many people are asking is: ”why buying mutual funds when you can buy the index directly?”. ETF’s are cheaper than mutual funds and will most likely perform better than mutual funds in the long run.

However, mutual funds are offering several advantages.

The main one is that it will reduce the volatility of your portfolio. That will not do any good to your end of year yield, but it will surely help you sleep at night. Even better, smaller fluctuations may not encourage your to sell compare to what you would have been through with an ETF’s. Several people overestimate their risk tolerance. That usually happens until they lose a big chunk of money within a month 😉

Benefit from professional expertise

If you want to invest in emerging markets or overseas companies, you might want to refer your money to someone who knows what he is doing. Then again, ETF’s can do a pretty good job but will engage much more fluctuation. Don’t forget that it is still possible to beat the market with mutual funds. It is just tough to find those very rare fund managers (like Sprott for example ;-)).

In the end, if you think that you can live with high fluctuations and you are ready to do your research carefully, you are probably better off with ETF’s. On the other hand, mutual funds will bring two big advantages: less volatility and a chance to beat the market. I would say that it is also much easier to make a financial plan with a steady 7% (even though it can fluctuate between -8% to +15%) than variation in the range of -20% and + 40%. The most important thing is to get to your goal, not how you made it 😉

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Comments

I don’t understand this article … how do mutual funds have both less volatility and higher performance? Remembering my MBA finance, volatility and returns move in the same direction. To get high performance you need to get into something more volatile. Of course, it is very very easy to get into something MORE volatile with LOWER returns, which is where I consider managed mutual funds compared to the market.

I honestly don’t know how ETFs work and why anyone would buy those over an index fund. What about the transaction costs? MER still applies too no?

If you know enough to get into sectors like resources, or developing economies, then learn a little more and get into specific companies. With even 50K you could get a 10K stake in 5 equities, which is more than enough to find some decent and diverse exposure. Keep the rest invested in indexes.

Let’s not make a virtue out of necessity. Mutual funds tend to hold some cash but an index investor can achieve the same thing by splitting her portfolio into cash, bonds and equities and lower the volatility. Why would you pay a manager 2% or more on the cash portion just because you want lower volatility?

“Chance to beat the market”. Yes, definitely. But a high probability of lagging the market too.

“you are ready to do your research carefully”. I don’t know what research you need to do. You pick a suitable index and buy the lowest cost fund to track that index. End of story.

by: The Financial Blogger | April 21st, 2008 (12:10 pm)

CC;

and then you have to live with the fluctuation. I completely agree with your point, the problem is that people can live with EFT’s when they are up and they sell the minute they go down 10% 😉

by: The Financial Blogger | April 21st, 2008 (8:58 pm)

CR;
If you take a fund manager like Helen Bond for example;
over the past 12 years, she beat the TSX by 3% (annualize) with less volatility. It is rare, but it does exist. This is why you must make your research carefully.

Mclean Budden did the same thing with the S&P 500…

Probably there are a few managers that are good and deserve their 2% or 3%. However, your article talked generically of mutual funds, and the generic group of mutual funds are not very good for the reasons that most people already know. Market beats them in the long run, even those who show several years in a row are just lucky, survivorship bias favours the lucky, etc.

Why not just recommend Helen Bond or McLean Budden instead? Someone might read your story and go to their banks to buy mutual funds 🙂

By EFT’s don’t you mean ETF’s?

by: The Financial Blogger | April 27th, 2008 (4:41 pm)

Right… I can’t write 😉 ETF 😀

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