Playbook #117: Mutual Funds

🖼️ The Big Picture

Mutual funds might be the most popular passive investing option available to investors today… 

And if you’ve been a part of the Wealth Factory community for a while, you probably know that they’re actually an investment strategy that we stand against for most people. So WHY are we devoting an entire playbook to them? Good question…

The truth is, our biggest issue with mutual funds is actually less about the financial instrument itself… and more about how they’re being sold. 

The typical “pitch” goes something like this:

• “Are you an expert on investing? No. So let us professionals do it all for you”
• “Here’s a hockey stick graph of how your money can grow large enough for you to retire someday”
• “Do you want low risk/low returns, medium risk, or high risk/higher returns?”

And then they are ushered into a mutual fund focused on one of those three categories. Each comes with a  hefty sales commission and then annual fees that erode your earning power.

So while mutual funds can be a "set-it-and-forget" type investment (which is appealing to many non-investors), it comes with a heavy price tag that isn't realized until it’s too late. Because just like compounding interest doesn't start adding up to significant amounts until later in the cycle, compounding fees work the same way. That means as your nest egg grows, so do the fees, and they can really add up over time. Just a 1% annual fee will gobble up 18-20% of your nest egg by the time you retire.

Another thing we don’t like about mutual funds is that investors are encouraged to abdicate responsibility for their results to someone else. 

They’re told not to worry about cash flow and just focus on accumulating enough to retire “one day, some day.”

And they’re made to believe that you have to take more risk if you want higher returns. 

Our philosophy centers around taking accountability and responsibility for your results, using your Investor DNA to increase your returns while lowering your risk - focusing on cash flow, not accumulation. 

So you achieve Economic Independence as quickly as possible - and don’t wind up in a spot 40 years later where you finally look at your statement and wonder why you can’t retire.

See the fundamental difference in philosophy? 

Now, just because we don’t like how a lot of people sell them — and how a lot of investors use them, doesn’t mean that mutual funds are innately bad. Because there’s no doubt, some people have done very well by picking high-performing mutual funds. Dave Ramsey is probably the most vocal advocate, and claims to have earned millions of dollars using the 4 types of mutual funds — and he claims he's beat the market averaging 13.04% returns over the last 40 years (with the S&P averaging 11.81% over that time). We'll let you decide if that sounds overinflated 🙂.

Ultimately, every opportunity comes down to your Investor DNA. And if your Investor DNA aligns with allocating a portion of your portfolio into mutual funds, then that’s great. Go in with your eyes wide open, and use your Investor DNA to pick great funds and minimize fees.

In this playbook, we’re going to get on the other side of the fence and share why mutual funds can work, what you should look for, and how to take more of an active approach to your portfolio so that you’re not just delegating all responsibility for your investing success (like so many people do).

First, what exactly are mutual funds?

Mutual Funds allow investors to pool their money together in a structured way to access a diversified portfolio of stocks, bonds, or other securities with the goal of spreading out risk and maximizing potential returns.

They’re similar to ETFs, except that they’re managed by investment professionals who charge higher fees and closely monitor the market, analyze data, and make informed investment decisions on behalf of the fund's shareholders. This offers individual investors the chance to benefit from the knowledge and expertise of experienced professionals, even if they do not possess that level of investment acumen themselves.

Over the long term, some mutual funds have shown consistent outperformance compared to individual stock portfolios. This makes them an appealing choice for those who are looking to grow their wealth steadily and potentially achieve higher returns. Additionally, investing in mutual funds is accessible to a wide range of investors, as many funds have low minimum investment requirements. Investors can also set up automatic investments, allowing them to contribute small amounts on a regular basis.

Mutual funds can be classified into different types based on their investment objectives, asset classes, and risk profiles. Here are four common types:

1. Equity Funds: Also known as stock funds, these primarily invest in stocks of publicly traded companies. These funds aim to provide capital appreciation over the long term by holding a diversified portfolio of equity securities. Equity funds can focus on specific regions (e.g., U.S. equities, international equities) or sectors (e.g., technology, healthcare) to cater to different investment preferences.
   
2. Fixed-Income Funds: Also called bond funds, these invest in various debt securities issued by governments, municipalities, and corporations. These funds aim to generate regular income for investors through interest payments while preserving the capital invested. Fixed-income funds can vary in their risk levels based on the credit quality and maturity of the bonds they hold.
3. Money Market Funds: These funds invest in short-term, low-risk debt securities like Treasury bills, certificates of deposit (CDs), and commercial paper. These funds are designed to provide investors with a safe place to park their cash and earn modest returns with minimal risk. Money market funds are often considered as an alternative to traditional savings accounts.
4. Balanced Funds (Asset Allocation Funds): Balanced funds, as the name suggests, aim to strike a balance between capital appreciation and income generation by investing in a mix of stocks, bonds, and sometimes cash or other asset classes. The asset allocation in these funds can be fixed or flexible, allowing the fund manager to adjust the mix based on market conditions and investment objectives.

It's important to note that there are many other types of mutual funds, including specialty funds that focus on specific industries, geographic regions, or investment strategies (e.g., growth funds, value funds, index funds, sector funds, etc.). 

If you already have a 401(k) or IRA, it’s likely invested in mutual funds, and you may want to check in on your portfolio performance and have a conversation with your financial advisor after reading this playbook. As always, use your Investor DNA and do your due diligence to review the fund's prospectus so you know what you’re investing in.

🔢 By The Numbers

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CAPITALIZE is a tool for discovering new ways to grow your wealth. You get a new investment idea each week in a simple 7-Minute report. Quickly check to see if it matches your "Investor DNA" and fast-track your way to being a top 1% investor... with less risk. Created by Wealth Factory for people who want to build their wealth and keep it.