Could Your Mutual Funds Be Hurting Your Retirement?
Over half of American households own mutual funds, totaling a collective $28.6 trillion last year. 90% of these mutual funds are actively managed and costing Americans tens of billions in fees each year.
For years, active mutual funds were the go-to, offering professional management and an easy way to diversify, which made them favored options for employer-sponsored plans. What were once distinguishing benefits, are now table stakes.
Index funds and ETFs (exchange-traded funds) offer the same benefits with a more streamlined approach. These products come with the perks of heightened transparency, lower costs, greater tax efficiency, and in most cases, stronger performance.
Regrettably, the mutual fund model is increasingly seen as more burdensome than beneficial. Many argue that has become inefficient and outdated.
Here’s how mutual funds may be chipping away at your nest egg.
High Fees
The costs associated with actively managed mutual funds can be significant and carry both visible and hidden charges. Sales loads to compensate brokers, high expense ratios for management and marketing costs, and additional transaction costs can all eat into your investment. A front-end fee of 4-5% is not uncommon, meaning only 95 cents of every dollar is actually put to work, instantly putting you at a loss.
When you add up the total cost of owning a mutual fund, it may hover around 2-3% and that’s not even counting any additional financial advisory fees.
Tax Inefficiency
Mutual funds can be extremely tax-inefficient. Investment gains are distributed directly to fund holders, typically at the end of the year. Consequently, you may be liable for tax on the entire year’s gains, even if you haven’t held the fund for the full year.
Subpar Investment Returns
The track record for actively managed mutual funds isn’t exactly stellar. Most fail to beat their benchmarks. For example, the S&P 500 has consistently outperformed 86%, 85%, and 92% of large-cap active mutual funds over a 5, 10 and 15-year period.
Diversifying across multiple active funds doesn’t necessarily help either, as it can actually increase the likelihood of underperformance.
Despite the claims of mutual fund managers, statistics show that investors are often left with less than those who simply opt for the index.
The Verdict
Active mutual funds often come with high costs, tax inefficiencies, and disappointing returns.
Index funds and ETFs are typically more cost-effective, passively managed alternatives. They operate differently from mutual funds, trading similarly to stocks, which enhances their tax efficiency since the underlying securities aren’t required to be sold for cash withdrawals.
If done correctly, lower fees tend to lead to better investment results. The key to reaching your retirement goals lies in reducing resistance along the way.
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