Andrew Allentuck

Friday, April 20, 2001

Stop Buying Mutual Funds: Easy Ways to Beat the Pros Investing on Your Own
by Mark J. Heinzl
2nd ed, John Wiley & Sons, 214 pages

Mutual funds have been hyped for decades as the small investors' first, last and best crack at wealth accumulation. Compared to savings accounts at financial institutions that may pay only fractions of one per cent interest, mutual funds are all those things. But compared to the performance of benchmark indices, funds are dreadful laggards.

Wall St. Journal reporter Mark J. Heinzl pointed out the lagging performance of mutual funds in benchmark comparisons in the first edition of this book, published in 1999. In the first edition, he makes the basic points that fund costs, including management fees, sales fees and taxes on distributions reduce investor returns. Now, in the second edition, he adds information on exchange traded funds that have low management fees and that invest in such things as the S&P 500, the top 60 stocks on the TSE ranked by capitalization, the Dow Jones Industrial Average's 30 stocks and so on. His point, borne out by data, is that if managed funds tend over time to underperform indices, one should either buy low fee indices themselves in the form of index funds or ETFs or skip the funds entirely and buy stocks.

Buying stocks outright and holding them for long periods should produce superior returns to those attained by mutual funds. But it is harder to do this than Mr. Heinzl lets on. Volatility scares some investors into selling prematurely, for investors tend not to remember that price moves tend to cancel out over the long run. There are trading costs, bookkeeping headaches, and always the nagging question of when to sell off stocks that turn into dogs.

Over time, the Canadian mutual fund industry, which now offers many times more funds than does the U.S. fund industry on a per capita basis, will have to rationalize and reduce the number of funds that it offers. The current plethora of about 4,000 funds shows that, when fees are high enough to let management companies grow rich at the expense of unitholders, reform has to happen. U.S. fund fees tend to be much lower than those in Canada and, as Canadian investors become more sophisticated and seek out funds with reduced fees, the rationalization process should move ahead. Until then, Stop Buying Mutual Funds is both a prophetic book of what lies ahead and a manual for investors who want to keep more of the returns of their money at risk and give less of it to underperforming managers.