Save Your Money - Buy Stocks, Not Funds
Fri, Sep 11, 3:22 PM ET, by Kenneth C. Bateman
We all know the old saying:
"Give a man a fish and he eats for a day, but teach him how to fish and he eats for a lifetime."
If there is an investment broker corollary to this, it is:
"If you broker a trade you generate commission income for today, but if you get someone to invest in a vehicle that scrapes off basis points every year we make income forever."
And so the great investment vehicle production game was set into motion, first with the development of mutual funds, hedge funds, and ETFs. I would not spend too much time worrying about hedge funds, because they generally have "high water" mark fee structures, which limits the amount the manager can make. What is available to us are the mutual funds and ETFs, which reward their managers with a generally consistent return, regardless of their performance. Many funds and ETFs charge a decent size fee, up to 20 basis points, even though they are not responsible for picking the actual underlying investments. Rather they perform only a minimal function of re-balancing the holdings determined by others, yet dutifully pickup the management fee. Only in the sinister world of finance could such a system be seen as even remotely legitimate.
Why do people allow themselves to be involved in investments that state explicitly they will not beat the market, yet allow the administrators to charge a fee. I think the concept of the diversified portfolio, or at least the public's perception in the idea of the diversified portfolio, has led the charge. And it is been a very lucrative charge indeed.
There is a persistent belief that a having small investments over a broad number of equities will protect an investor from a "catastrophic fall." To be sure, it is reasonable to never keep all your investments in one stock. But why 500? Why 30? Wouldn't a grand total of 20 stocks be fine? Believe it or not, most companies do not spontaneously blow up a la Enron. Most are fairly stable, and every single one has SEC filings that are released every 90 days and tell you exactly what they are doing and their financial status.
But why do financial planners suggest the money into funds or ETFs? If they sell you a share of common stock in a company, then they make $10 on the commission and move on with their lives. But the golden goose is to create a customer that will consistently deliver income for as long as they hold the funds. Second, by having funds consisting of several hundred companies, they really don't have to do much research -- instead, they can focus on making sales to customers.
SDI Glossary: "ETFs" Definition
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