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Question: Why are there so many mutual funds?
Answer: Mutual fund management is profitable, so it creates more products that sell on Wall Street.
A large number of mutual funds has nothing to do with serving your interests as an investor. We use proprietary data to identify two red flags you can use to avoid bad mutual funds:
1. High fees
Mutual funds should be cheap, but not all. The first step is to consider what cheap means.
To ensure you’re paying at or below average fees, invest only in mutual funds with total annual expenses below 1.61% – our average total annual expense of $5,922 US equity style. The weighted average is low at 0.89%, which shows how investors keep their money in mutual funds with low fees.
Figure 1 shows that the American Growth Fund Series One (AMRBX) is the most expensive style mutual fund, and the Vanguard 500 Index Fund (VFFSX) is the least expensive. American Growth Fund ( AMRBX , AMRAX , AMRGX ) offers the three most expensive mutual funds, while Vanguard ( VFFSX , VSTSX ) and Fidelity ( FXAIX , FSKAX ) mutual funds are among the least expensive.
Figure 1: 5 Most and Most Expensive Style Mutual Funds
Investors should not pay high premiums for quality holdings. American Century Capital Equity Income Fund (AEIMX) is a low-cost, best-rated style mutual fund. AEIMX’s independent portfolio management level and 0.06% annualized total expense make it very attractive.
On the other hand, the T. Rowe Price Mid Cap Index Fund ( TRSZX ) holds weaker stocks and has an unattractive rating but low total annual expenses of 0.08%. No matter how cheap a mutual fund is, if it holds bad stocks, the performance will be bad. The quality of mutual fund holdings is more important than the price.
2. Weak Holdings
The hardest part of getting rid of bad mutual funds is getting rid of bad holdings, but it’s also important because mutual fund performance depends more on its content than its price. Figure 2 shows the mutual funds in each style with worst holdings or portfolio management levels.
Figure 2: Style Mutual Funds with Worst Holdings
Morgan Stanley’s funds appear more heavily than the other providers in Figure 2, meaning they offer the most mutual funds with the worst holdings.
Morgan Stanley Discovery Portfolio (MMCG) is the worst-rated common stock in Figure 2. It is a fund. Morgan Stanley Insight Fund (MBIRX), Baillie Gifford US Discovery Fund (BGUIX) (TSNRX), Legg Mason ClearBridge Mid Cap Fund (LSIRX), ProFunds Small Cap ProFund (SLPIX), Longleaf Partners Fund (LLPFX), Bertolet Capital Pinnacle Value Fund (PVFIX), and MSS Series Footprints Discover Value Fund (DVALX) as well. A very unattractive forecast overall rating, which means not only poor savings, but high total annual costs.
The danger in
Buying a mutual fund without examining its holdings is like buying a stock without examining its business model and financials. Put another way, research on mutual fund holdings is important because mutual fund performance is only as good as the holdings.
Performance of Mutual Fund Holdings – Fees
EES
Disclosure: David Coach, Kyle Guske II, Matt Shuler and Brian Pellegrini receive no compensation for writing about any particular stock, style or theme.
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