Holding too many investment funds can hurt you

Holding too many investment funds can hurt you
Eileen St. Pierre, The Everyday Financial Planner

I’ve seen a lot of investors who own way too many mutual funds. Financial advisors never seem to recommend selling funds. That’s because most get paid when you buy in, not when you sell. If they really had your best interests in mind, they would determine if the fund met your investment objectives. If it didn’t, they need to explain to you why it doesn’t and recommend you sell it. There is no shame in selling. Holding too many investment funds can hurt you.

Some funds may not be suitable.

You may not have understood the investment objectives of some of your funds. Perhaps they were not explained properly to you. While I can tell a lot by looking at the fund’s name, at a minimum I always look at the fund’s summary prospectus to determine if it meets my client’s needs.

It is important to update your financial plan. Your investing goals and risk preferences may have changed and a fund may no longer be suitable.

Some funds may not be necessary.

Do you know what securities your funds hold? I like to go to www.morningstar.com, look up the fund’s ticker symbol and get Morningstar’s free reports. If I see a client who has three funds that basically invest in the same securities, I pick one for them and encourage them to sell the others. Here are some factors I consider to help me make my decision:

excessive fees

  • What is the fund’s annual expense ratio? Do you just have to pay a management fee or is there also a 12b-1 fee? A 12b-1 fee is a fancy word for a marketing fee – part of which goes to the advisor who recommended the fund.
  • What is the turnover ratio? If the portfolio manager is constantly buying and selling securities in the fund, this will increase the annual expense ratio. Is there a reason the turnover has to be so high?
  • Is there a redemption fee? In other words, do you have to pay a fee to sell the fund?
  • Even though past performance is not a guarantee of future performance, how well have the funds performed over the past five years?

Diversification can now be achieved with one fund.

Instead of trying to select funds to meet your investment objective, you may be able to find one fund that holds the right mix of individual funds already. The best example here are Target Date and Lifecycle retirement funds. These funds hold a mix of stock and bond funds and gradually re-balance your portfolio towards a safer basket of securities as you approach your retirement date. 

Fees can really add up over time.

If you have to pay sales charges or front-end loads to buy into a fund, that’s less money for you to invest upfront. Let’s say you invest $10,000 in a mutual fund that charges a 5% front-end load. You will only invest $9,500 of that money; your advisor will keep $500. If that money is invested at 8% for 10 years, you will earn $1,080 less than if you had invested the full $10,000.

For more information on investing, visit my Basic Financial Management page.

Diversify Across Asset Classes, Not Investment Managers

Diversify Across Asset Classes, Not Investment Managers
Eileen St. Pierre, The Everyday Financial Planner

Retirement nest eggOne of the biggest mistakes I see many investors make, especially highly intelligent people, is confuse the concept of diversification. We all can recite the phrase “Don’t put all your eggs in one basket” but what does that phrase really mean? It means don’t put all your money in one single asset, whether it be a single stock, gold, or your home. If something bad happens to that asset, you’re left with nothing. The company could go bankrupt, your gold could get stolen, and your house can burn down right after you let your homeowner’s policy lapse. Diversification across asset classes is the key.

It is possible to be well-diversified by owning just a single mutual fund or ETF (like a life cycle or target date retirement fund) that holds a collection of stocks, bonds, and other asset classes. You’re probably thinking to yourself there’s no fun in that. The key is finding the right investment company.

Which investment company should I choose?

Many people feel that if they spread their money around to several different investment managers, they are bound to hit it big. What they don’t realize is that this can be a very expensive strategy. Many funds marketed through investment companies charge initial sales charges, called front-end loads. I’ve seen them as high as 5.75%. So if you invest $10,000 in a fund that charges 5.75% to buy in, that’s $575 for the privilege of buying that fund.

  • If they would separate out the fee from your investment, many people would think twice. Would you write out a check for $575 without questioning it?
  • The investment company is going to keep your $575 and only deposit $9,425 into the fund.
  • If you hold this fund for 10 years and it earns an average of 8% a year, you are missing out on an additional $6,210 because of this initial sales charge.
  • Are you getting your money’s worth?
  • If you give your money to five different investment managers, the fees can really add up.

Choose an investment company that charges low fees and stick with that company.

In addition to front-end loads, companies can charge 12b-1 fees (0.25% to 1%) to market the fund and redemption fees to sell your fund. All funds will charge a management fee so it is important to compare management fees with funds of similar styles.

Don’t worry about not having enough funds to choose from with that company. My column Investing Basics: Mutual Funds 101 has more information on how to pick a fund. Depending on your investing goal, you can build a well-diversified portfolio with just a few funds. If I see a new client with more than five funds, I ask them why they need them all. If there is no valid reason, it may just be to increase the commission paid to the representative. Reps always seem to want you to add funds, but do any suggest selling funds? They get most of their money when you buy in.

Withdrawing your money from multiple companies can be a nightmare.

If you lose track of where all your money is, you may not be able to keep your optimal asset allocation to meet your investing goal. I’ve seen this so many times with retirement accounts.

  • If you have five different accounts with five different providers, what is your overall asset allocation? You need to understand the big picture.
  • When you turn age 70 ½ and it is now time to make required minimum distributions (RMDs), you will face a 50% penalty if you do not withdraw enough money.
  • If all your retirement accounts are transferred to one company, making RMDs becomes so much easier.

Ok, you may have figured out by now I am a Vanguard girl. They charge some of the lowest fees in the business and provide me with more investing options than I need. No, they are not paying me to say this. I’ve had to read enough long, boring articles in my former life as a finance professor to know that active portfolio management does not work. You cannot consistently outperform the market. So I accept the risk of the market and do not expect to earn more than the market will give me. And I’m sure as heck not going to pay any more than I have to!

Visit my Basic Financial Management page for more information on investing.