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Is it worth investing in mutual funds?

- Alan Lavine and Gail Liberman

We've been taking a great interest lately in reading why mutual funds are so terrible.

Perhaps that's because we're coauthors of The Complete Idiot's Guide to Making Money with Mutual funds (Alpha)" as well as mutual fund investors.

Take Louis Lowenstein's book, "The Investor's Dilemma. How Mutual Funds Are Betraying Your Trust and What To Do About It (Wiley)." It levels serious charges about the self-serving interests of investment companies.

Lowenstein's complaint: Mutual funds have wandered too far afield from the core principles upon which they were founded. Those core principles are to provide the average investor with good professional hands-on management and low portfolio turnover at a reasonable cost.

Among Lowenstein's complaints about mutual funds:

  • They've been growing assets fast and launching new mutual funds for the sole purpose of reaping fees from more assets under management.

  • Too little attention to performance.

  • Over-reliance on computer programs and portfolio rebalancing--tactics guaranteed to foster only mediocre fund performance.

  • A move to t eam management of funds--virtually guarantying to investors those individual funds will not get adequate attention.

  • Failure of fast-growing funds to close their doors when they become too big. This, he reported, leads to the fund's ownership of too many stocks and fosters too much trading to perform well.

  • Rampant conflicts of interest.

  • Manipulation of benchmark indexes, disclosed to help shareholders measure a fund's performance. The benchmarks selected are designed to portray their performance in the best possible light.

    A lot of these charges may be valid. Yet, we continue to invest in mutual funds. Why? If you pick them carefully and broadly diversify, they still can present one of the best investment values today. They're also better than other options for regular investing because you needn't pay commissions on individual stock trades.

    Lowenstein, who seems to have a love-hate relationship with mutual funds, offers the following suggestions on what to seek in a manager-run mutual fund:

  • A small fund--with just about 30 to 40 stocks in companies with good management and strong businesses. By contrast, a typical stock fund has 160.

  • Low turnover rate. The greater the turnover rate, typically the higher the expenses and taxes. A 25 percent or less turnover rate is best.

  • Check out a fund's performance over both a five-year and 10-year period. Be sure to examine it in down markets.

  • Se ek funds whose managers put a lot of their own money in a fund.

  • Seek a fund whose managers talk in their reports about visiting the company--not just reading computer screens.

  • Vast management experience.

    What about index funds, which are the mutual funds in which we mostly invest? They have no manager.

    Lowenstein offers a valid criticism. Although over the longest of time horizons, indexing washes out market ups and downs, many people are too impatient to hold them long term.

    The annual redemption rate in the Vanguard 500 Index Fund, for example, has averaged 20 percent over the past few years, he says. That's not much better than the 25 percent rate in stock mutual funds.

    Meanwhile, those who redeem early lose the value of an individual manager's stock picking ability, yet wind up paying accompanying taxes and expenses.


    Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.

    To read more columns, please visit the column archive.

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