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Why I Avoid Mutual Funds
September 13, 2012
By Peter C. Thoms, CFA
Founder, Orion Capital Management LLC
Before starting my own investment firm here in Coronado in 2002, I worked for a large investment company called PIMCO, serving as the co-portfolio manager of an equity mutual fund called the PIMCO Growth & Income Fund. After having been involved early in my career in managing mutual funds both as an analyst and portfolio manager, I now only very rarely invest any of my clients’ assets in mutual funds. Why?
Simply put, the vast majority of funds charge too much, trade too much, are inefficient from a tax perspective and deliver sub-par investment returns to their investors. When you examine funds using a cost/benefit analysis from the investor’s perspective, very few mutual funds have any business being in business. For the fund companies, however, mutual funds are a wonderful business.
Years ago mutual funds helped to democratize the stock market, as they provided individual investors a means to buy a diversified and professionally managed portfolio of stocks without paying commissions for each individual stock. Back in those days, however, it was actually expensive to trade a stock. I still remember my parents paying nearly $200 to their Dean Witter broker in the 1990s to buy a mere 200 shares of Intel. Today such a trade would cost $10 or less.
The mutual fund industry is losing assets at a rapid rate—in the last three years outflows have amounted to $546 billion, about 5% of total industry assets. Yet there are still 52 million households in the U.S. that own funds, 650 fund sponsors and $11.6 trillion in assets under management industry-wide. Investor apathy and lack of knowledge about the alternatives to mutual funds are probably why the fund industry has still managed to hang onto significant assets despite its inferior product offering.
The reality is that there are now cheaper and more tax-efficient ways to invest than mutual funds.
I invest my clients’ assets almost completely in individual securities and exchange-traded funds (ETFs). An ETF is basket of securities that typically tracks a benchmark, such as the S&P 500 Index or the MSCI Emerging Markets Index. Most ETFs are passive investments in that there is no trading going on in the ETF except that which is necessary to keep it matched to the benchmark. ETFs have been around since 1993, but in recent years their numbers and types have proliferated. Broadly speaking, they are useful investment vehicles that merit consideration from all investors.
A portfolio of ETFs and individual securities is simply more cost-effective and tax-efficient than a portfolio of mutual funds and can be more finely tuned to reflect an investor’s specific preferences and objectives.
While mutual funds remain a powerful force in the investment world today, they are on the wane.
As usual, I welcome your comments and feedback.
Peter C. Thoms, CFA
Orion Capital Management LLC
1330 Orange Ave. Suite 302
Coronado, CA 92118
About the Author:
Peter C. Thoms, CFA, is the founder and managing member of Orion Capital Management LLC, an independent Registered Investment Advisor based in Coronado, California. The firm manages assets for individuals, families, trusts, corporate pension plans and non-profit organizations.
This document is for informational purposes only. Nothing in this report is to be construed as a specific investment recommendation. This document does not constitute the provision of investment advice, which is only provided by Orion Capital Management LLC under a written investment advisory agreement and only in states in which Orion Capital Management LLC is registered or is exempt from registration requirements. Orion is not a tax advisor and does not provide tax advice. For tax advice individuals should consult their CPA.
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