Sunday, January 11, 2004

Mutual Funds Had a Good Year - Don't Buy Them
So says the Washington Post (at least the first part about them having a good year).
After listening to the gospel of Prof. Grundfest (old SEC chairman currently teaching at Stanford Law), here is what I don't get - why invest in a fund other than an index fund in the first place? Over time, all funds are going to return the market rate, and mutual funds will have that return reduced by two factors (1) Costs, (2) Unethical Cheaters. The only way you are going to be able to find a fund that will beat the market over the long run is to find the fund with top notch analysts that can over time (and through skill not luck) beat the market. Even if these analysts exist, do you really think that they will be working at a mutual fund? Hell no! They'll go cater to people who have the real wealth to play with at a hedge fund. The analysts that stay at these mutual funds are either the inexperienced analysts or the ones that didn't have those skills (or the ones that haven't had a ridiculous lucky streak yet). So basically at a mutual fund you are paying for analysts who have yet to do squat (consistently beat the market) and have less than a 50-50 chance of doing it in the future.

The problem gets worse though when you realize that even if you DO get lucky and make more than the S&P, your gains have probably been reduced by cheaters. The most simple scam is that a larger customer, after seeing a fund go up during the day, gets a corrupt employee or officer of one of these funds to let them buy into a fund after it closes. Let's say that the fund closes at 4:00. All subsequent trade orders for the fund will take place the next morning. Next, let's say that at 4:30 there is an announcement that productivity grew at 7.5% that quarter when the market was only expecting a 1.5% growth rate, meaning profits are much more likely to be up. The market will rise very sharply the next day, along with mutual funds, but that only benefits the people who already own stock. Those that don't own stock or want more stock will have to pay extra for this good news.

But what happens if you had a time machine and could go back in time? You'd buy stock by the boatload! Well time travel is possible on wall street - just get a corrupt official at 5:05 at a mutual fund to say that you put an order in at 3:59 for stock, and viola! you now traveled in time and owned stock that you didn't own when the announcement was made. As the amount of stock that the fund owned didn't change (because the fund didn't get your order in time to actually buy any more stock), the only way that you are able to have profits is by reducing the rest of our profits. Basically, you steal your profits from the rest of the honest shareholders.

Far fetched? Guess what - it happened, and was much more widespread than most grandmothers with nest eggs wanted to think. Read all about it here.

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