What the SEC Really Thinks About Mutual Funds!
Let’s get into the details of why non-index mutual funds are so bad. When Arthur Levitt became the head of the Securities and Exchange Commission in 1993, he had to sell all of his individual shares so people wouldn’t say he was doing dirty business from the inside. He decided to put the cash from the sale of his stock portfolio into mutual funds.
Mr. Levitt got very angry when he tried to figure out how particular mutual funds divided their cash into specific stocks. He couldn’t get his head around the fancy mutual fund brochures called prospectuses. He had been a major player in stockbrokers for more than 25 years at the time and he knew that if he couldn’t understand the prospectus of the mutual fund, he knew that the public investors couldn’t either; it had to be a big scam to get money out of the public.
In 1980, the American public invested $100 billion in the 500 mutual funds in existence at the time. By 1993 the public invested $1.6 billion in the more than 3,800 mutual funds that existed in that year; talk about growth! At the end of February 2003, at the bottom of the bear market there were 8,200 mutual funds and the public had injected $6.3 trillion. wow! That’s a lot of money. What’s important to note is that at least 40% of the money in mutual funds comes from 401(k) retirement accounts. Today, these mutual funds own around 20% of all publicly traded stocks. Mutual funds act like a herd of cows buying and selling the same stocks at the same time. This increases the sharp swings in price volatility in the stock market.
These funds are also sold and managed on pure hype, short-term trading, and with key information from the public. All of these factors that I teach finance students and investors to avoid! The industry misleads investors by focusing on past performance, which should not be a factor. Many mutual funds are able to mislead the public with excessive fees because investors don’t understand how these large fees destroy their profits. Mutual funds have no interest in educating investors because it is easier to fool the ignorant!
Don’t trust mutual funds unless they are fully indexed. Indexing means that the mutual fund simply uses a computer to buy and sell shares in the mutual fund’s portfolio to mimic the composition of a major stock index like the S&P 500. This means there is no fund manager to absorb unnecessary fees. A good example is the first fully indexed mutual fund called the Vanguard 500 (VFINX), which is also now the largest of its kind.
