A client called me up recently, not necessarily in panic-mode, but definitely motivated to talk and act quickly. He mentioned that he re-read my book and in re-reading it the second time around, in his words, “a light went off.” To paraphrase: “If the market goes down, these mutual fund managers can’t do anything about it. They will stay invested!” I need to do something about the funds in my 401k!
We set up a brokerage-linked account (a new-er feature some 401ks provide) and moved the money away from the limited options his company offered (something I call “The 401k Handcuff” in Chapter 5 of my book Unconventional Investing, Alternative Strategies Beyond Just Stocks & Bonds and Buy & Hold). Now in a brokerage account with thousands of investment options, we constructed a more dynamic portfolio that is designed to better protect him from the next major bear market.
Although I would love to elaborate on my criticisms related to work-based retirement plans and their limited options, the focus of this blog is to highlight a common misconception many average investors hold in relation to the managed money.
As I point out in Chapter 3 of my book, the majority of the mutual fund world has become too compartmentalized and focused, often only investing in certain niches within specific asset classes. As a result the majority of funds have to manage to a benchmark (like the S&P 500 in the case of a large-cap fund), and attempt to outperform after fees. Moreover, they cannot concentrate positions (emphasize their best ideas) or reposition to a more opportunistic asset class (like bonds or cash) in the face of a challenging market, and as a result, outperforming after fees can be a challenge. This is why low-cost index funds and ETFs make for more suitable investments than approximately 70 - 80% of managed mutual funds. If a fund is going to closely resemble an index, but include another layer of expenses, why not go with the more cost efficient option?
Nobody enjoys a peak to trough 50%+ decline as we experienced in 2007 - 2009. Many assumed that their mutual fund managers could and would implement hedging strategies on their behalf. But, they didn’t (and probably couldn’t) and if history were to repeat itself, my message to you is to better understand the system and have proper expectations moving forward. If the protocol outlined in the prospectus isn’t what you want? Consider other options. This is about becoming smarter consumers. Purchase the funds and hire the managers that are aligned with your wants and desires. Again . . . Otherwise you are probably better off just owning low cost index funds and ETFs.
This begs the question to fund managers: What are you doing with your own money? How do you invest? I would love to believe that you would treat my hard earned money like your own. Do you? Do you eat your own cooking? If it is supposed to be good enough for others than it should be good enough for you, right? Don't be naive to think that your mutual fund manager is invested the same as you (his or her customer) is!
*Note: As I point out in my book, some fund managers do invest in their own funds and alongside other shareholders, but this is the exception and not the rule. In addition, to defend many fund managers, they are just doing the job they were hired for, which is to run a targeted / non-diversified fund. But, many common investors (I assure you) are unaware of this.
I vividly remember the experience of purchasing my first car, a Nissan Altima. I was young at the time, and remember how in love with the car I was especially after listening to the salesman (who I thought was my best friend for 15 minutes) speak so glowingly about the car. I still remember how disappointed I was when I later found that he doesn’t drive an Altima or even Nissan, but rather a Chevy? Huh? I was convinced that he believed in his product and must drive one himself. Say one thing, do another.
I realize with hindsight how naïve I was, especially when it comes to auto sales. Wouldn’t you, like me, want to see more people who implement what they recommend, use what they sell, stand behind their product/advice? Wouldn’t you love more transparency across all fields and professions (mechanics, plumbers, advisors, doctors, dentists, etc.)?
· Would you replace this part?
· Do you use this product?
· Is this a prescription you have or would recommend to a family member?
· Have you or would you have this procedure done yourself?
And if not, which is ok, can you tell me why?
We could have fun with this list. . .
I think nowadays people don’t want to be sold. I think they want trusted advisors that want to be treated as if they were family to that professional. In addition, after 2007 – 2009 I think people want to know what their hired managers are going to do if we were to face another tough bear market. Because, doing nothing, is something people can do on their own and at no cost (at least in terms of an expense ratio).
On a personal note: my book outlines what I am doing personally and why I am doing it. Not only do I eat my own cooking, but I have provided my detailed recipes as well.