Monday, August 2, 2010

Beware Mutual Fund Ripoffs

Mutual funds should be easy to compare.  All of them basically work the same way.  You give the mutual fund a chunk of money and, in return, it gives you back some amount of money minus some fees.  Therefore, it should be pretty easy to separate the good ones from the bad ones.  However, people seem to have trouble doing just that, because there are so many junk mutual funds that have literally billions of dollars in assets.

Let's take a simple U.S. large company mutual fund.  This is a mutual fund that invests in the stock of large U.S. companies like Apple and Coca-Cola.  If you were interested in investing in this sector, you could invest in a brand name fund like the Wells Fargo Advantage Endevor Select Fund (symbol STAEX).  This fund has the Wells Fargo brand name associated with it, and it has the word "Advantage" in the name.  So far so good.  On top of that, it has $1.3 billion in total assets, so a lot of people have entrusted their money to it, so they must be doing something right.  Right?

Let's look at the numbers.


First, this fund has a load of 5.75%.  That means that Wells Fargo takes 5.75% of your money up front.  If you invest $10,000 in this fund, $575 gets taken away right off the bat, so you end up investing only $9,425 in the fund.

Second, this fund charges you an annual fee of 1.25% of all the money you have invested.  So if your initial $9,425 happens to grow to $10,000 in a year, Wells Fargo takes another 1.25% from you, so you are knocked back down to $9875.

Now you would think that a fund that charges this much money would employ the best investment analysts who can then use their superior knowledge to make the fund's investors lots of money.  Well, you would think wrong.  The fund's average annual performance over the past 5 years is -1.62%.  In other words, you are paying 5.75% up front and 1.25% per year so their supposedly great stock pickers can lose -1.62% of your money each year.

Now maybe you think that this is pretty good considering the stock market as a whole has been in the tubes recently.  Let's compare this mutual fund to a fund which simply buys the 500 biggest U.S. companies and holds them, like the Vanguard 500 Index Fund (VFINX).  As an index fund, this fund doesn't employ stock picking to make money.  It simply buys and holds the S&P 500, which are the 500 biggest U.S. companies. 

Because it doesn't need any high priced Ivy League investment analysts, the expenses are quite low.  There is no load, meaning that if you give $10,000 to the fund, all $10,000 get invested.  In addition, the annual fee is only 0.18%.  That is only $18 for every $10,000 that you have invested.  So I am sure you thinking that such a low cost, bare bones fund would do worse than the super stock pickers at Wells Fargo, right?  Well, you would be wrong again.  The Vanguard Fund had an average annual return of 0.03% over the past 5 years.  The cheapstakes at Vanguard who basically just forgo stock picking for buying everything are doing better than the high priced folks at Wells Fargo who are supposedly using their super powers to pick the best stocks.

So let's recap:

Wells Fargo
Up front fee:  5.75%
Annual fee:  1.25%
Average 5 year return:  -1.62%

Vanguard
Up front fee:  0%
Annual fee:  0.18%
Average 5 year return:  0.03%

The real question is why have people invested $1.3 billion in a fund that charges you a premium but doesn't deliver a premium service.  I don't have the answer, but I know that I am not foolish enough to give my money to Wells Fargo.

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