Investing 101

The biggest issue facing mutual funds is not the competition of other mutual funds – it is index funds. Sadly, most mutual funds don’t hit even the bogey of the index fund return – AND they charge a lot more in fees/load – AND they buy and sell stocks a lot so they “realize gains” for tax purposes.

Do the math:

The S&P 500 Index is up 8% in an average year (average S&P index return for 100 years). Take Index or ETF is ticker: SPX. SPX charges 0.25% in fees with no loads. The ETF is super duper easy to buy and sell and there are no sales commissions (the brokerages who sell them get paid a tiny amount out of the monthly fees). So in an up 8% year, the investor shows a net gain after taxes of 8 – 0.25 or 7.75%. (There are almost none because the ETF doesn’t really trade much if any stocks or bonds in the index other than to rebalance.)

A median mutual fund investing in the same arena might return 6.5%. Let’s give hope the benefit of doubt and assume you were lucky enough to pick the top 20% of all mutual funds (think about that – it’s a huge benefit of the doubt) and that fund trades below the average “churn” of 50% . They “only” realize 30% of their net short term gains and 20% of their long term gains. In an up 8% year then, of the gain of 2.4% of short term gains, they cause you to pay about half of those gains back to the government (assuming you are in a Socialist state like California or New York) plus the Federal taxes plus other taxes and that you are in because of your reasonably high tax bracket.

Of the 2.4% you give back 1.2% to The Man. And that’s for the short term gains.
For the long term gains, you give back 25% in a normalish tax bracket situation. Of the 20% of 8% gains, that yields to you 1.6% and you give back 0.4%.

But wait! There’s more!

You have much higher fees in a mutual fund than an index fund so you pay that part first… let’s say you have a middlin’ load/no-load kind of fund and pay say, 1% a year, properly amortizing any load you might have.

Your return of 8% is 7% after fees. Then subtract the 1.2% of ordinary income gains and then another 0.4% of long term realized gains. Your nice 8% market return just became 5.4% versus the 7.75% return of the index fund.

It might not seem like much; however, the difference of that 2.35% per year over the course of a retirement lifetime leaves you with literally HALF of the money to retire on if you’ve been invested in this situation/scenario for 25 years.


If it sounds complicated, tough. You need to know this stuff. It’ll save you a fortune when you’re gray.

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