Question: Why are there so many mutual funds?
Answer: Mutual fund management is profitable, so Wall Street creates more products to sell.
The large number of mutual funds has little to do with serving your best interests as an investor. I leverage this data to identify two red flags you can use to avoid the worst mutual funds:
1. High Fees
Mutual funds should be cheap, but not all of them are. The first step is to benchmark what cheap means.
To ensure you are paying at or below average fees, invest only in mutual funds with total annual costs below 1.84%, – the average total annual costs of the 622 U.S. equity Sector mutual funds my firm covers. The weighted average is lower at 1.15%, which highlights how investors tend to put their money in mutual funds with low fees.
Figure 1 shows Saratoga Financial Services Portfolio (SFPAX) is the most expensive sector mutual fund and Fidelity Real Estate Index Fund (FSRNX) is the least expensive. Saratoga provides five of the most expensive mutual funds while Vanguard mutual funds are among the cheapest.
Figure 1: 5 Most and Least Expensive Sector Mutual Funds
Investors need not pay high fees for quality holdings. Fidelity Advisor Energy Fund (FIKAX) is one of the best ranked sector mutual fund overall. FIKAX’s neutral Portfolio Management rating and 0.71% total annual cost earns it a very attractive rating.
On the other hand, Vanguard Real Estate II Index Fund (VRTPX) holds poor stocks and receives an unattractive rating, yet has low total annual costs of 0.10%. No matter how cheap a mutual fund, if it holds bad stocks, its performance will be bad. The quality of a mutual fund’s holdings matters more than its price.
2. Poor Holdings
Avoiding poor holdings is by far the hardest part of avoiding bad mutual funds, but it is also the most important because a mutual fund’s performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each sector with the worst holdings or portfolio management ratings.
Figure 2: Sector Mutual Funds with the Worst Holdings
Vanguard, T. Rowe Price, and Fidelity appear more often than any other providers in Figure 2, which means that they offer the most mutual funds with the worst holdings.
Jacob Internet Fund (JAMFX) is the worst rated mutual fund in Figure 2 based on my predictive overall rating. BNY Mellon Natural Resources Fund (DLDYX), Vanguard Utilities Index Fund (VUIAX), LDR Real Estate Value Opportunity Fund (HLRRX), and Fidelity Select Defense and Aerospace Portfolio (FSDAX) also earn a Very Unattractive predictive overall rating, which means not only do they hold poor stocks, they charge high total annual costs.
The Danger Within
Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on mutual fund holdings is necessary due diligence because a mutual fund’s performance is only as good as its holdings.
PERFORMANCE OF MUTUAL FUND’s HOLDINGs – FEES = PERFORMANCE OF MUTUAL FUND
Read the full article here