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    February 2016
    M T W T F S S
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    Are Mutual Funds Worth It?

    Steve Nyvik

    “If you don’t like the idea that most of the money spent on lottery tickets supports government programs, you should know that most of the earnings from mutual funds support investment advisors’ and mutual fund managers’ retirement.” – Robert Kiyosaki


    Written by Steve Nyvik, BBA, MBA, CIM, CFP, R.F.P.
    Financial Planner and Portfolio Manager, Lycos Asset Management Inc.

    What is a Mutual Fund?

    A mutual fund is a type of investment fund where investors buy units directly from the fund and the proceeds are invested by a professional investment manager in a variety of securities according to the fund’s stated investment objectives.  Such investments may include stocks, bonds, and money market instruments.

    The mutual fund is known as an open-end investment fund as it can raise an unlimited amount of investment capital by continuously issuing new units.  The units don’t trade on a stock exchange, rather investors buy or redeem (sell) their units directly from the fund at the fund’s Net Asset Value Per Share (NAVPS) plus any applicable sales charges.

    All income, expenses, gains and losses of the fund are shared amongst the unitholders based on their percentage ownership of the fund.

    The main advantage of a mutual fund is that it may represent a cost effective way to gain access to a particular professional investment manager.  And for small amounts of money, which can be as low as $250, it is invested in a diversified portfolio rather than concentrated in one or a small number of investments.

    The main disadvantages of a mutual fund include:

    • potentially high sales charges – Front-end load or Deferred Sales Charges (DSC);
    • fund expenses (which include legal fees for putting together the prospectus, accounting fees, marketing and advertising expenses, investment management fees to pay the fund manager and investment trailer fees that are paid to the salesperson who sells you the fund) which cut into returns;
    • professional management is not infallible;
    • the fund manager may be forced to sell assets at depressed prices when unitholders choose to redeem units;
    • the manager does not customize the investments according to your particular situation or preferences as the manager may be dealing with thousands of fund holders;
    • you have no input as to how it will be managed or what it will own;
    • you normally won’t be able to view the fund’s holdings other than when it publishes them periodically – typically on a semi-annual basis; and
    • you normally don’t have access to the fund manager to freely call him or her to enquire about the fund. The fund manager normally won’t know who you are.

    When it is Worth Having a Fund Manager

    The key issue is whether the fund manager is able to add value.  Is the manager skilled and able to generate returns, net of costs, in excess of a comparable market index or generate similar returns to the market index but do so with less risk.

    Determining this is not an easy task.  When outperformance in term of superior net returns or in terms of better risk adjusted returns occurs, we need to have some idea of whether that was due to skill or luck.  We want to know this to gain confidence of whether such added value is likely to be repeated in the future years.

    Identifying Skill

    A skillful investment manager might be identified:

    • where the manager utilizes an investment strategy that is sensible, the variables screened for are materially significant and directly relate to financial performance, and enough securities are selected to generate the strategy returns to reduce the effect of randomness;
    • by learning the manager’s investment philosophy on constructing and managing a portfolio in terms of both risk and return;
    • by examining the manager’s background, education, experience and character including:
      • relevant investment education;
      • investment experience and experience managing portfolios;
      • age;
      • intelligence;
      • rational temperament;
      • self-confidence, independent thinking and creativity;
      • patience;
      • competitiveness; and
      • a passion for investing
    • by examining through time the manager’s performance net of fees compared to the comparable market index. A consistent history of outperformance can be indicative of skill.

    But at What Price?

    Robert Kiyosaki’s quote may be a little exaggerated but does highlight the issue of costs.  Consider a mutual fund with an all-inclusive management expense ratio of 2.3%.  This fund comprises of a fund manager fee of 1.0%, the trailer fee of 1.0% to the investment adviser and 0.30% for expenses.  On top of this would be any sales charges.

    If you have more than $100,000, you can do better.  You can instead hire a portfolio manager that also customizes your portfolio according to your cash needs, risk tolerance and investment preferences.  Some of these portfolio managers can also offer you financial planning advice and service.  And this portfolio manager knows you and you deal direct with him or her.  Your cost could be cut in half putting more money in your pocket.  Now how’s that for building a better mouse trap?

    The MONEY® Network