Thu, 12 Jul 2018 20:11 IST
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Mutual Funds – Internally Inconsistent

There is a lot of debate about whether mutual funds are an idea from the past. Many people have written book saying that the idea is obsolete and that savvy investors should stay clear of the same. The reasons that they give for the same are many. However two reasons stand out which make the idea of mutual funds look internally inconsistent i.e. illogical. They are as follows:

Transaction Cost: Ask any savvy investor why they don’t like mutual funds and they will usually give you the same answer, “transaction costs”. Mutual funds are made and operated in such a way that it is impossible to avoid transaction costs.

The Asset Management Company (AMC) takes its chunk of management fee regardless of whether the fund makes or loses money.

There are charges to enter and exit a mutual fund. Funds are known for reckless short term buying and selling. The huge turnover of stocks creates huge transaction costs as well.

When you consider all of these costs, you find out that your return has been cut by at least 5% to 10%. Savvy investors like Warren Buffet have been known to say that they avoid transaction costs. Mutual Funds seem to be a good idea if you were a broker!

Conflicting Objectives: An investor’s objective is to obtain the maximum long term return that he can. In fact, returns above normal can only be made in long term investing with at least 5 to 10 years horizon. But, Mutual Funds invest to show results every quarter and sometimes every day. They seem to be chasing the market and buy whatever is rising and sell whatever is falling. This not only creates transaction costs that were mentioned above but also ensures that investors are not able to truly realize the potential of fundamental long term investing. The expertise and analysis that you pay the fund management company for is never used!

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