Mutual funds as an investment offer a variety of benefits. They allow individual investors access to a managed and diversified portfolio of assets within the capital markets which would otherwise be difficult to do as an individual investor. They also take advantage of their buying and selling size to reduce transaction costs for the investor. As well, they are fairly liquid, with investors being able to buy or sell their investment with relative ease.
Though mutual funds boast many benefits, there are also many myths regarding mutual funds, and some even by the very people working in the industry. Separating fact from fiction in the financial industry is not always as simple as it ought to be. With this in mind, here are 10 of the biggest mutual fund investing myths debunked.
Be sure to also see the 7 Biggest Mistakes to Avoid When Investing in Mutual Funds.
1. Mutual Funds Are Safer Than Single Stocks
This is not necessarily true. Diversification is preferred and recommended, but it does not guarantee less risk. There is no guaranteed return with mutual funds because at the end of the day a mutual fund only consists of the investments that it owns and the values of these can fluctuate day to day just as with single stocks. This holds true for any type of asset class.
2. Investing in Overseas Markets Is “Too Risky”
When purchasing an international fund there are other factors to take into consideration, such as currency risk, political risk, and inflation. However, these investments offer diversification benefits and can offer higher returns in growing economies. Further, there are a variety of asset classes in overseas markets with lower or higher levels of risk just as with domestic investments, whether that is equity funds, bond funds, money market funds, balanced funds or specialty funds.
3. Mutual Funds Are Expensive
There are plenty of cheap index-based funds; do your research and find the cheapest fund and share class that is right for you. The average mutual fund charges around 1.3% to 1.5%. Broken down, a mutual fund’s management expense ratio includes the cost of hiring the fund manager(s), the admin costs with running the fund, and brokerage commissions. Investors should look at the MER to see if it is competitive, and remember the lower the better.
4. The Highest Rated Funds are the Best
Remember that past performance does not guarantee future returns. Further, rankings and ratings can also be deceiving. Various publications will often release a list of the top mutual funds, and fund managers love to brag that their fund is in the top 10 or top 100. However, as an example, if the bottom 5 or bottom 50 mutual funds are underperforming against their benchmark, then they have no right to be bragging. While lists can be helpful, investors still need to do their due diligence before making an investment decision.
5. Mutual Fund Investing Is “Hands Off”
Even for a passive investor, they would be doing themselves a huge disservice not to regularly check their portfolio and see whether or not their mutual funds are performing according to their objective. They should also rebalance regularly to ensure proper diversification. This is not to say that investors should pursue active management, but keeping an eye on their portfolio is key, especially if the fund’s manager changes hands.
6. Big Is Bad
Not necessarily true. While a larger fund may have difficulty beating the market, it does not mean that big is always bad, especially with bond funds and money market funds. Their increased purchasing power drives down annual expenses which in turn increases returns.
7. Investors Can Only Buy Mutual Funds from a Certified Advisor
There are many different ways that an investor can invest in mutual funds. The top three methods are advisors, banks, and brokerage houses. Each method offers mutual funds and different levels of service when making an investment decision. Ultimately it should be up to the investor to decide which fund is best for him/her.
8. Mutual Funds Have a Low Rate of Return
Some of the best investors in history have been mutual fund managers, including Peter Lynch, John Neff, and T. Rowe Price Jr. As an example, Peter Lynch managed the largest actively managed mutual fund in the world with his Fidelity Magellan and ran it from 1977 to 1990 with an average return of 29.2% per year. Investors would be hard pressed to find a better investment during that period of time. While most investments, let alone mutual funds, do not have returns that high, the point is that mutual funds can have just as high of returns as other investment vehicles if not higher.
9. It Is not the Fees That Matter but the Returns
The bottom line performance of a fund matters, but investors need to look at the MER, or management expense ratio, of the fund to see the impact it will have over the long run. The importance of the MER will depend on the type of fund as well. The MER is generally more important for a more conservative mutual fund where there are smaller differences between the top performers and worst performers. With stock funds, the MER plays a part in differentiating top performing funds, especially over a long period of time.
10. Returns Are Dependent on the Manager of the Fund
Many investors believe that the investment fund manager determines the greatest return for the portfolio. This is not true. The most important decision made is by the investor when deciding what fund to purchase. This is why it is important to look at the fees, investment objectives of the fund, historical track record, and if it is within the investor’s own risk tolerance before making an investment decision.
Be sure to also see the 7 Questions to Ask When Buying a Mutual Fund.
The Bottom Line
The trick to investing in mutual funds is to separate fact from fiction. If investors do their due diligence they will know what to look for and how to avoid getting tricked by common investing myths regarding mutual funds.