Hating Mutual Funds?

Hello once again, it is Mr. Stilman's Opus. John Stilman here, joined today by Mark Silverman. Mark is a certified financial planner in Tucson, Arizona. I wanted to talk with him today about mutual funds, but Mark, thanks for being here. I'm happy to be here, John.

Always good to talk with you. You hate mutual funds. Let's cut right to the chase. Why is that? Well, hate is kind of a tough word. I dislike mutual funds. And don't get me wrong, I started this business over 21 years ago, and primarily that's what we use was mutual funds, specifically loaded mutual funds. But I think the investment horizon has definitely gotten better for folks. I know it has. Fees have come down.

The products have come have gotten better. There's better ways out there than mutual funds, in my opinion. And I'm not knocking if you have a 401k through work and all you have is mutual funds.

You know, I'm not saying don't contribute to the 401k because you got to make the best of what you have available. But if you have outside money and you're in control of what you can buy, I wouldn't personally buy mutual funds. I think you're better off buying either individual securities or even ETFs. I think ETFs is a great way to go, which is exchange traded funds. And there's lots of benefits of ETFs over mutual funds. And quite honestly, there wasn't ETFs available when I first started the business. So we were using mutual funds.

Yeah. So explain what that means. Exchange traded fund. That is what we use primarily in our portfolios here, too. But just explain exactly what that means. How is it different from a mutual fund? Sure.

Yeah. I mean, they're both buckets of securities, whether it be stocks or bonds or a combination of the two. I think there's certain differences that are that are available with ETFs over mutual funds, one being transparency. With the ETF, you know exactly what you own.

With the mutual fund, as soon as they print what's in there, the portfolios change. So you never really know exactly what you own. A couple of other things are fees. On average, the fees of an ETF are probably 80 to 90 percent less per year in fees, which is significant, especially in a low interest rate environment like we're in right now and will probably continue to be in for the near future. The other thing also is a tax efficiency. So if it's in a retirement account, it's not so much of an issue. But outside of retirement accounts, ETFs are a lot more tax efficient, meaning you're not paying quarterly capital gains, dividends and interest every quarter, no matter what. With ETFs, they inherently are just more tax efficient.

And then I think the other thing also that you have to consider when you're buying an ETF is getting in and out a lot quicker. So when you own a mutual fund, I always use the example of 9-11, which we're coming upon here in the next 15 year anniversary coming up next month. But when you're talking 9-11, if you have a mutual fund and let's say you wake up and the market's down 600 points and you say, I want to get out of my mutual fund, you go to sell it, John.

The problem is it doesn't get executed until the end of business day. So now the market's down over 1,000 points and you've lost even more. If you had that same portfolio in an ETF, you get out instantly. You don't have to wait for the market ticket to close to get out.

So you can get in and out a lot quicker. So it makes it a little more efficient as far as getting in and out of different portfolios. More like buying or selling a stock.

It's groups of stocks or baskets of stocks or bonds or whatever it is. So you still have the diversification of a mutual fund but without some of those costs and tax issues. Why are the costs so different?

Well, the costs are different for many reasons. With mutual funds, mutual funds are designed and there's lots of hidden fees and expenses that are in there. Most people are so focused on, and I'll reference the article, John, that I use, is there was an article that came out in Forbes in 2011, The Real Cost of Owning a Mutual Fund. And in that article, which I'm sure you've seen, they estimate the total cost of a mutual fund anywhere from three to four percent per year. Most people are just focusing on the expense ratio, which is one of the fees that's disclosed in the prospectus, which of course nobody reads.

There's also another document called the Statement of Additional Information, which is not sent out. You actually have to request it on each mutual fund you own that disclose other fees such as trading costs, because quite honestly, the fund doesn't know how many times they're going to buy and sell when there's a lot of volatility, which we see nowadays. The other thing you have to think about with all this volatility that's going on, there's a thing called cash drag. What that means is these mutual fund portfolio managers have to hold on to quite a bit of cash for a lot of redemption, especially when the markets are volatile.

And as we know, cash doesn't earn anything. So that brings down the performance, the returns of the mutual fund. So there's lots of different things in there. And so all these different fees, like I said in the article, you can you can Google it and find it on there.

But they estimate about three to four percent. So there's lots of hidden fees and expenses, which you don't have with ETF. So like I said, on average, you're probably saving somewhere between 80 to 90 percent per year in expenses. And since I know you work the same as I, John, since we don't make revenue off of mutual fund expenses, why not put that money back in the client's pocket? Because it's just a much better way. And I get a lot of clients that will come into the office and who are using mutual funds and they say, why doesn't my advisor ever mention this to you? And I always have to say, well, if you've been content and haven't been really complaining about what your what your adviser has been doing for you, why would they recommend something that's going to put less money in their pockets?

It's just not going to happen. Right. Well, and that's the thing to understand about mutual funds. In a lot of cases, they're being sold for a commission, right?

Correct. There's loads, there's different share classes, which can be very confusing. There's of course, the A share class, which has a load you pay five and three quarters percent to get in. There's also B shares, which are kind of going away.

But those don't have anything to go in. But you pay a surrender charge to get out and have a higher expense ratio. And then we still see what's known as C shares, which you pay one percent to get into. And they have a higher expense ratio forever. So they can end up being very, very expensive. You know, but one of the things with mutual funds are and I think that's by design is that the fees are not transparent. So if you're paying three or four percent on a mutual fund, it comes off your return. So you don't see that on your statement.

You're not going to see it anywhere. And I've always said, it seems like people don't have a problem paying a fee when they don't see it. Where they do have a problem, then I can show them where our fees are maybe half or whatever it may be, but they see our fee.

It's very transparent. But you know, that's something that they have to overcome. Yeah. It's the same thing with us. Our fee always seems higher because it's all disclosed. But at the end of the day, it's actually considerably lower than the combined costs that they're going to have in a mutual fund laden portfolio.

So pretty interesting when you break it down that way. Do you ever use individual securities, individual stocks and individual bonds, or just ETFs? No, we use individual securities as well. It just depends on the portfolio. So depending on the size of the portfolio and what the situation is, we will use individual bonds, individual stocks, etc. But depending on, again, the size of the portfolio, it's hard to get the diversification if you can only buy, you know, two shares of Google or something like that. So we end up using ETFs for a lot of our folks and they're getting the diversification they need at a low cost. Again, Mark Silverman, certified financial planner in Tucson, Arizona. Silverman and Associates, he's online at SavingWithSilverman.com. Mark, thanks, man. Happy to be here. We'll talk to you next time right here on Mr. Stilman's Opus.