BOSTON — Whether you follow Wall Street or not, odds are you’re a mutual-fund investor. Mutual funds are the foundation of 401(k) plans and individual retirement accounts.
Yet many investors lack the patience to learn the finer points of funds, or give up trying. They’re intimidated by jargon such as “expense ratios” and “basis points.” Such fear can lead to poor choices that lock in years of high fees and subpar returns.
Still others think they know their stuff and mistakenly move in and out of pricey funds that are hot performers, however fleeting. Over the decades, seemingly trivial differences between the returns funds deliver and the expenses they charge can have a huge impact on retirement security.
A good starting point to a successful long-term strategy is recognizing misperceptions that trip up many fund investors. Below are top myths that three experts highlighted in recent interviews:
It’s easy to find a good actively managed fund. Just pick one that’s been beating the market
Actively managed funds typically charge more than index funds because of the payroll costs for the investment professionals calling the shots. Research by Burton Malkiel, a Princeton University economist, and others shows that the strong returns of active funds are almost always fleeting when measured against the decades needed to save for retirement.
You get what you pay for in investing — higher fees generate bigger returns
It’s tempting to choose a fund that’s been posting big returns lately, even if it charges higher- than-average fees. That’s because gains from the manager’s recent picks can make fee differences look puny. But expenses are a definite and easily measured drag on future returns. Over time, costs are almost always a bigger factor in fund returns than investment selection, Malkiel says.
All mutual-fund fees are bad
Many funds assess sales charges upfront, along with the ongoing expenses that cover operations. Yet there’s another one-time charge that might make long-term investors money: redemption fees, according to Michael Finke, associate professor of personal financial planning at Texas Tech University. About one-quarter of funds charge investors who pull out of a fund shortly after getting in, typically within six months or less. The charges are capped at 2 percent of the amount invested.
These fees became common after a scandal in 2003 when some funds were caught favoring certain big investors who frequently moved in and out of the funds.
Research co-authored by Finke showed that many mutual funds that charged redemption fees had significantly higher average returns than comparable funds that didn’t charge — as much as 3 percent in some instances. Advantages were most apparent for funds investing in stocks of small companies.
You need more than one mutual fund
Investors are told to mix things up by investing across the stock market and include bonds as well as alternative assets such as gold or real estate. The implication is you need several funds. Finke argues most investors would do fine with just one fund, provided it has a broad focus.
All index funds are low-cost
Index funds typically charge less than actively managed funds, but there are exceptions. One reason: Index funds tracking the same market segment charge vastly different expenses. Expense ratios for funds tracking the Standard & Poor’s 500 run as low as 0.06 percent to 2.28 percent. Most of the pricier ones are burdened by small size, according to Russell Kinnel, director of mutual-fund research at Morningstar.
