Posted January 26, 2022
By Zach Scheidt
I Don't Like Mutual Funds — And Neither Should You
My friend Aaron shot me a text the other day:
"Hey Zach, what do you think about mutual funds? I'm frustrated with this market and think I'll just buy a fund instead."
Oof! I'm sure I visibly cringed reading that.
Since I'm not a registered financial advisor, I can't give Aaron any advice.
But I can share my thoughts with you here at Rich Retirement Letter. And today I want to tell you why I think most mutual funds are bad investments that you should avoid entirely.
More importantly, I'll explain why you can achieve much better returns because of the freedom you have as an individual investor.
Why Pay Someone to Do a Poor Job?
The problem with mutual funds is that most of them do an extremely poor job of growing your wealth.
And the ones that I've tracked do an even worse job of protecting your wealth when markets trade lower.
I've been around a lot of mutual fund managers during my career.
It seems like every conversation with these so-called professionals leaves me frustrated for the investors they're supposed to serve.
The job market for mutual fund managers is very competitive.
And because it's a high-paying job, most of these investors are much more interested in keeping their job than they are doing anything unconventional.
Mutual fund managers are judged on how their funds perform compared to a benchmark. So for a large-cap growth manager:
- They get a raise if returns beat the Nasdaq 100.
- They'll get to keep their job if they perform in line with the index.
- And they'll get fired if their fund trails the benchmark by too much.
Think about the safest way to keep that kind of job.
Most mutual fund managers decide to invest almost exactly the same way their benchmark invests.
So a manager who is judged by the Nasdaq 100 index will own the exact same stocks that are in this index.
Then, to justify their salary, the manager will make slight tweaks to this portfolio.
Maybe the fund will own a little bit more Microsoft (MSFT). Or maybe they'll underweight Meta Platforms (FB). But they're certainly not going to steer far away from the same stocks included in the benchmark.
After all, that would leave them at risk of underperforming and getting fired!
Here's my question to you... Why would you pay someone to manage your wealth like that?
You Can Do Much Better!
As an individual investor, you can do much better than most mutual fund managers. And this is true in both easy and turbulent market periods.
During easy market periods, you can decide to buy large positions in quality stocks that are trading higher.
And since you don't have to mimic an index, you can have more energy stocks when energy is strong... or you can be heavy in tech when that group is doing well.
And it doesn't matter if the S&P 500 has a similar —or very different — weighting to these groups!
Better yet, you can also decide to hold cash when risks levels are high. Or you can move your wealth into real estate, cryptocurrencies, precious metals or other plays.
Mutual fund managers are required to keep the vast majority of their assets invested at all times. That means when the market is turbulent, they're not even expected to try to protect your wealth and avoid losing money in a pullback.
It's a very convenient setup for the mutual fund manager.
If you call them up and ask why they didn't get out of clearly overvalued speculative stocks like DocuSign (DOCU), Peloton (PTON) or Roku (ROKU), you'll get a glib answer...
"They were part of my benchmark index... I had to own them!"
No, you can't expect a mutual fund manager to protect your wealth during a market pullback. That's entirely up to you.
The good news is that you can do much better on your own!
Especially with the help of great researchers like the investors we have here at St. Paul Research and specifically our team here at Rich Retirement Letter.
Today's Market Is About Value, Profits and Reliability
In today's market, you can protect and grow your wealth by proactively shifting to the areas that are rolling into favor right now.
And I may be a little biased, but I love the areas of the market that are surging higher.
As we've been showing you, value stocks — or stocks of companies that trade at low prices compared to company earnings — are some of the best-performing names in the market right now.
Dividend stocks are also outperforming the rest of the market, which is music to my ears!
How great is it that the stocks that pay you to hold them are also the ones with prices that are holding up better than the rest of the market?
Financial stocks will benefit from higher interest rates. And remember, we're just in the early stages of rising interest rates. So as this trend picks up momentum, bank stocks should continue to trade higher.
It's not too late to get on board!
Finally, I'm very bullish on energy stocks. And while this may not be the "politically correct" place to be, there is definitely a lot of profit to be made with oil and natural gas stocks.
Now I'm all for transitioning to alternative energy and being careful to protect our environment.
But we can't flip a switch and just quit fossil fuels cold turkey. If we did, millions of people would starve or freeze to death!
Oil companies still fill a much-needed place in our economy. And as oil and gas prices rise, these companies will continue to generate lucrative amounts of profit.
You can tap into those cash flows by owning many overlooked and under-owned energy plays. It's a group that should do very well as the economy reopens.
Bottom line: by focusing on the best areas of the market, you can beat a Wall Street mutual fund manager hands down.
So don't pay someone else to do a poor job of managing your money when you can handle it better on your own.
Here's to living a Rich Retirement,
Editor, Rich Retirement Letter