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 1.60% – the average total annual cost of the 5,732 U.S. equity Style mutual funds my firm covers. The weighted average is lower at 0.85%, which highlights how investors tend to put their money in mutual funds with low fees.
Figure 1 shows Northern Lights Issachar Fund (LIONX) is the most expensive style mutual fund and Vanguard 500 Index Fund (VFFSX) is the least expensive. Northern Lights provides two of the most expensive mutual funds while Vanguard and Fidelity mutual funds are among the cheapest.
Figure 1: 5 Most and Least Expensive Style Mutual Funds
Investors need not pay high fees for quality holdings. Schwab S&P 500 Index Fund (SWPPX) is the best ranked style mutual fund in Figure 1. SWPPX’s neutral Portfolio Management rating and 0.03% total annual cost earns it an Attractive rating. U.S. Opportunistic Value Fund (UUOAX) is the best ranked style mutual fund overall. UUOAX’s attractive Portfolio Management rating and 0.57% total annual cost also earns it a very attractive rating.
On the other hand, Fidelity Small Cap Index (VMCTX) holds poor stocks and earns an unattractive rating yet has low total annual costs of 0.07%. 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 style with the worst holdings or portfolio management ratings.
Figure 2: Style Mutual Funds with the Worst Holdings
No one provider appears more often than any other providers in Figure 2.
Alger Weatherbie Specialized Growth Fund (ASYMX) is the worst rated mutual fund in Figure 2 based on my predictive overall rating. Transamerica Capital Growth (TCPWX), Nuveen Small Mid Cap Growth Opportunity Fund (FMEFX), BNY Mellon Small Cap Multi Strategy Fund (MPSSX), Reaves Infrastructure Fund (RSRFX), CRM Mid Cap Value Fund (CRIMX), and Bertolet Pinnacle Value Fund (PVFIX) 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 model 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
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