Mutual Funds

All That Glitters is Not Gold

The vast majority of Americans have money invested in “the market”. By that is meant they are owners of stocks, bonds, mutual funds and other types of securities that have “market risk”. Mutual funds are oftentimes out-of-sight and out-of-mind in a 401(k), 403(b) or other retirement account. Generally, mutual fund owners do not carefully track their investments as they have taken a back seat and left the driving to professional money managers. If this has been your attitude, read carefully what follows.

The primary premise of mutual funds is that “professional management will beat the market averages”. This is simply not the case. The data show that over any given five-year period very few professional money managers are able to match or beat the market averages. There are many reasons for this – over-trading, hidden agendas, conflicts of interest and far too often skullduggery – but chief among them are high fees. In fact, mutual funds are loaded with fees ranging from front-end commissions for brokers, on-going fees for administration, advertising, printing plus mailing you information, and exit fees when the funds are sold. Annual fees can range from as low as 0.18% for index funds purchased without using a broker to as high as 3% for certain specialty funds. Fees are charged in bad markets when they add to losses and in good markets when they subtract from gains. Since mutual funds go as the market goes, how have they been doing in the past several years?

There are several measures of the stock market’s performance with the Dow Jones Industrial Average (DJIA) being the most cited and followed. The DJIA is closely tracked and reported as “the barometer” of the stock market. Unfortunately, inflation is rarely mentioned when the DJIA numbers are released. While inflation is less noticeable in the short run, over a longer period it has a very important bearing on how much your money will buy. Rising prices destroy the purchasing power of your money and must be considered when looking at the DJIA; however, rarely is “the market” adjusted for inflation. Let’s see what happens when this major oversight is taken into account and applied to the DJIA.

During January 2000 the DJIA reached a peak of 11,723 and then headed downward with the bursting of the dot-com bubble and reached a bottom in late 2002. In October 2007 the DJIA reached another peak of over 14,000 but at the beginning of September 2008 closed at roughly 11,500 – wiping out all the gains and about 2% more from the 2000 peak. What does the picture look like after adjusting for inflation?

In January 2000 the Consumer Price Index for all urban consumers (CPI-U) stood at 168.8. The CPI-U reached 219.96 in July 2008 (latest available) – a rise of over 30% since January 2000. In other words what cost $168.80 in 2000 had risen to $219.96 in mid-2008. Once inflation is taken into account, the DJIA actually lost over 25% because of the shrinking value of money. What does this mean for your mutual funds, and possibly your retirement?

Let’s say that you retired in early 2000 and had your retirement nest egg invested in mutual funds. Over the first couple of years you lost heavily but decided to ride out the bad market because you thought that in the long term you’d probably do just fine. Sure enough, the market turned in late 2002 and your mutual fund investment recovered nicely. But when the market turned again in 2007 you lost all your previous gains plus about 2% more. While the DJIA is about the same now as in early 2000, you’re not back to break even because of two very important factors.

First, inflation has taken over 25% of the value of your retirement money as prices have constantly marched higher independent of the ups and downs of the DJIA. Secondly, there is a very high probability that your mutual funds have underperformed the DJIA because only a tiny fraction of money managers match or beat the market average over time. Here are the questions: While you may do better in the longer term by putting your retirement money in mutual funds, can you afford the market risk? Do you have the time to wait until markets recover to make up for inflation and poor performance by those managing your money?

What can you do? You can diversify as you approach retirement’s red zone and redeploy some or all of your money now in “the market” to safer alternatives. There are bank CDs, government savings bonds, fixed annuities, money market accounts and other low-risk options. Granted, the return may not be so hot, but then again mutual funds have not exactly been setting the investment world on fire since 2000 with losses of over 25% after inflation. Don’t believe all the marketing hoopla about mutual funds and do not dismiss other safe-money options. Most of all find a financial advisor that offers more than stocks, bonds, mutual funds and “investments” with risk, plus always inflation-adjust your money over time. You retirement may hang in the balance!

Shelby J. Smith, Ph.D.

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