Do you currently have money in a 401(k) or 403(b)? If so, most of your hard-earned dollars are probably invested in mutual funds. As a rule of thumb, investing your money in a mutual fund is better than stashing all of your cash in a single stock or bond. After all, it’s better to diversify your investments to reduce your risk, which is why mutual funds aren’t an awful investment, but I believe they aren’t the best investment.
About a year ago, I met Andrew Hallam, a mid-30 year old millionaire that did not acquire his wealth with a high-paying job or a glamorous business venture. Nope, he’s making his millions with index funds on a teacher’s salary. I read his book, “Millionaire Teacher” and I was immediately convinced that Index Funds were the way to go with my investments as well. Over the course of 2012, my index fund investments have averaged over 14% growth.
Mutual Funds – the not so great investment
Like I said in the first paragraph, mutual funds are definitely safer than piling all of your money in one stock, but there are many reasons why you might want to shy away from these investments. Let’s quickly dig into these reasons.
1) High Fees
Mutual Funds are a conglomerate of many stocks of the same nature. There are mutual funds for restaurants, real estate, crude oil, tech companies – pretty much anything you can think of. They’re good because by owning a small share of many companies, your investment becomes safer. They’re bad because there are many employees of this mutual fund that are paid to try and beat the market. And, who do you think pays for these employee’s salaries and the building they’re working in? You do! with your 1.5% fees that you pay on your investment account each year, you are keeping this mutual fund in business. And, whether you realize it or not, these fees are eating up your investment profits!
2) Broker Fees
Many of you have Financial Advisors that help you invest for the future. Did you know that these advisors/brokers get paid from mutual fund companies to push their investment fund? It’s in your advisors best interest not to make you a bunch of money for your future, but to push a product (the mutual fund) that pays the most into their own pocket. On top of that, you are paying your broker a fee each year to handle your investment accounts for you, even if you lose money.
3) Sub-par performance
Many Mutual Funds believe they can beat the market. Some do for a short period of time, but overall, it has been confirmed (by Andrew Hallam in fact) that over the long haul, Index Funds have outperformed Mutual Funds. So, if you are investing in Mutual Funds, you are actually earning less money per year, and you’re paying a higher fee!
So What Are Index Funds?
Just like Mutual Funds, Index Funds are a conglomerate of different stocks, but instead of having a team of employees trying to beat the market, Index Funds are set up to mimic a specific index, like the S&P 500, the Nasdaq, or the Dow Jones Industrial Average. Since they aren’t managed every second of the day, they have extremely low fees (like 0.09% instead of 1.2% in a common mutual fund). Also, they are much simpler to understand and purchase, which means that there’s no need for a broker (eliminate the broker fee). And, as I just stated, they have historically earned more than the average mutual fund! All signs point toward Index Funds for me, how about you?
Mutual Funds vs. Index Funds For The Long Term
The fees of 1.2% just seem so small don’t they? Is there really that much difference between paying 1.2% for a mutual fund vs. 0.09% for an index fund? Let’s test out an example and find out!
Let’s assume that you’re 35 years old and plan on retiring when you’re 65. You’ve already acquired $100,000 in your retirement account and have just decided to let the interest earn you the rest of your income until your retirement years. If you put your money into a mutual fund that earns an average of 14% each year, and has a fee of 1.2%, how much will you have after 30 years?
Mutual Fund Results – $4.6 million
Index Fund Results – $6.3 million
Now, let’s say your index fund investment equals the mutual fund’s (even though it’s historically more) at 14%. With a fee of only 0.09%, let’s see how much you’ll earn over the course of 30 years compared to the $4.6 million in the mutual fund.
The results are in. That seemingly miniscule percentage difference impacted your retirement fund in a huge way! I mean $1.7 million huge! If I had the choice between $4.6 million and $6.3 million, I’d take the $6.3 million. Wouldn’t you? I suggest that you take a serious look at your retirement accounts and see if index funds are right for you!
What do you think about Index Funds vs. Mutual Funds?