A couple of years ago, I worked for an investment bank. My job, like most first-time employees, consisted mostly of getting coffee for the professionals and generally doing squat. But when I wasn’t wasting my life trying not to spill the coffee all over the rug, I was phoning clients to sell to them our mutual funds. (Sounds fun, doesn’t it?)
Like any industry that’s not all black-and-white, the mutual fund industry is full of its dirty little secrets that investment advisers like my boss don’t tell you. For the sake of privacy, I won’t disclose the name of my boss or the investment bank where I worked.
So basically, in this post I’m going to shed some light on things that investment advisors DON’T tell you about mutual funds.
The True Purpose Behind DSC
DSC stands for Deferred Service Charge. When you buy into a mutual fund, you’re “locked in” for a select period. So how does the mutual fund “lock you in”? They can’t legally say “you’re not allowed to sell your shares in this mutual fund before a certain date”. Mutual funds can’t legally lock you in, but they can heavily discourage you from selling your shares before a certain date.
To deter you from selling before a certain date, mutual funds place a Deferred Service Charge on your mutual fund shares. This means that if you sell your shares before a certain date, the mutual fund will charge you X amount of dollars (usually in the couple of hundreds). Now here’s the trick that mutual fund companies don’t tell you. DSC plays on a dirty little trick that involves human psychology.
The average human prefers a large probability of something small over the small possibility of something big. They’ll forgo large opportunities just for the sake of small safety. At certain times, the value of a mutual fund will fall (obviously). What DSC does is deter investors from selling a mutual fund that’s losing money. So essentially investors in the mutual fund have to choose between 2 choices:
1. Face the possibility of even larger losses should they keep their shares in the mutual fund.
2. Bail the hell out of the losing investment and pay a several hundred dollar fee.
The interesting thing I noticed is that a ton of investors will keep a stock that’s lost thousands of dollars just so that they don’t lose a few hundred dollars on the DSC. This doesn’t make any sense!
So essentially, DSC locks you in for years and years just because you (the investor) is afraid of losing a measly $200 on the DSC. If you look at it logically, a tiny 2% fluctuation in your investment is greater than the value of the DSC! So by blindsiding you with this DSC, the mutual funds are making you forget about the greater losses you can incur should the mutual fund generate crappy returns.
So what I suggest you do in the future is forget about the DSC. Do not put DSC into consideration when you ponder selling your mutual fund before the lockin date. Remember – even a tiny fluctuation in the market price of your mutual fund is far greater than the value of the DSC.
Most Mutual Fund Managers’ Slides are Just Copy and Paste
In a span of 8 months I went to 20 something different mutual fund managers’ presentations. Essentially, each mutual fund would send one representative to our bank and pitch us on why we should sell shares in their mutual fund to our clients. But by the 8th presentation I started to realize something – those Powerpoint slides were practically all the same!
The reality is, there is usually little to no difference between the various mutual funds. All those mutual fund managers promising outlandish investment returns? Yea, most of it is hocus pocus. 99% of mutual funds just follow the times. If emerging markets are hot, all the mutual funds will have slides up explaining why their emerging market mutual fund will be up 49% next year. If commodities like gold are hot, every mutual fund will be telling you about the super awesome prospects of the gold market.
So my point is, when you invest do not spend a lot of time deciding which mutual fund to invest with. Spend more of your time deciding which market to invest in. Once you’ve selected your market, just go out and buy the most popular mutual fund. Most of the mutual fund managers are exactly the same.
Mutual Funds Generally Underperform the Stock Market Average
I bet this is something you didn’t know. When you pool together all the returns of the mutual funds, the investment returns are actually less than what the S&P500 returned. Why?
This is because mutual funds have pretty high cost structures. Think of the mutual fund salesman doing a roadshow – he has to be paid his salary by the mutual fund company. Think about all those “researchers”. They have to be paid as well!
All these employees on the mutual fund company’s payroll translate into hefty cost centers. And like any business, these costs are passed onto you, the customer (mutual fund investor). So prior to all those fees mutual funds charge you, mutual funds on average may match the performance of the S&P500. But add in all these fees, and investment returns of mutual funds tanks.
I hope you enjoyed this post! Unfortunately, I don’t blog about finance. However, if you want feel free to check out my site at http://www.ghostforbeginners.com/. Cheers, and enjoy the rest of your day!