Buying Mutual Funds Through an Investment Advisor?......Think Again.

An investor that directs his own investments was contacted recently by the large firm where his account is maintained.  They told him they felt he could benefit from having one of their investment advisors manage his account.  He turned the account over to the advisor, and guess what the advisor did?...sold off all his individual stock positions and put the client into mutual funds.  The client's expectation was that the advisor he had hired would proactively manage his account, and watch his account during the day while he was at work.  Instead, he got to pay fees to sell off his existing portfolio, fees to purchase mutual funds, fees to the advisor, and in some cases, will experience redemption fees to sell the mutual funds, and his account is being less actively managed.  The "advisor" did his job, and did it well.  His job was to increase revenue for his company, and he was quite successful.

Another client came to me who had an advisor who used mutual funds exclusively.  On the day she opened her accounts, the money was placed into mutual funds with dividends automatically reinvested.  Not one single transaction had been made since then, approximately four years ago.

Prior to the bubble bursting at the beginning of this decade, the majority of money invested in mutual funds came directly from individuals and their 401K plan selections, while investment advisors primarily selected securities for the clients.  This disturbing trend, where investment advisors simply put their clients assets into mutual funds, has been increasing in recent years, to where it has now become the majority vehicle used by most firms.  Why?

After the debacle of the last decade, investment professionals are reluctant to stick their necks out and select securities.  The funds they select are typically equal to or less than the client's risk level.  With the heavy level of diversification, it is less likely that a portfolio will crash and burn, as so many did a few years ago.  In most cases, portfolio volatility will be reduced.  It is designed to provide a ride that avoids the big bumps that might scare clients away. With all the fees the client is paying, it is very difficult to obtain out performance.

The primary value of a mutual fund is that it provides diversification to the investor.  With all the index funds, ETFs, CEFs, iSHARES, sector funds, etc that are available today, how much value is there to a mutual fund, which only trades once a day, does not allow the client to specify limits, does not disclose internal transactions costs to investors, charges the shareholder for their marketing expenses, and is loaded up with enough fees to make one's head spin?  In a large way, mutual funds have outlived much of their usefulness.  Mutual funds were more valuable to the investment community years ago, when the aforementioned investment vehicles did not exist, not that mutual funds have ever been great investments.  Historically, that vast majority of mutual funds have underperformed the S&P index.  Paying someone to invest your money in mutual funds is akin to paying someone to pump gas into your automobile.  You used to do so years ago, but in this era, very few any longer see value added in doing so.

Most mutual funds are sold to the general public, there is no need to go through an advisor.  The actual  investing is done by the fund managers, the advisor is primarily a sales agent.  The advisor can argue, "I picked the best performing fund(s), this fund was number one last year".  So what, anybody can look up the historic performance of funds, rankings of mutual funds are easily available through numerous sources to the public, it is not research, it is not something worthy of payment to an advisor.

As a client, you want the most direct path to the individual who is doing the actual investing, which is likely to be a person with a passion for the markets, not an agent who sells funds, who's passion is for asset gathering and sales.  I acknowledge they are excellent salespeople, and very smooth.  They will often have a glib and sardonic response to everything I have mentioned.  One IA who does primarily mutual funds told me "if clients want to do individual stocks, they can do that on their own".  Huh?  You consider your clients more capable of selecting individual securities than yourself?

Putting you into mutual funds and calling you, or "touching" you once or twice a quarter is not active management.  Active management is monitoring your account every market day, taking advantage of opportunities when they occur, not reviewing and adjusting at quarterly or annual boundaries.  A person who puts you into mutual funds then spends his day on the phone cold calling is a salesperson, regardless of what it says on his business card.

You should know all the components of an advisor's compensation for managing your assets, but you will not if he is utilizing mutual funds.  Firms will often have different compensation arrangements with different fund companies, and an advisor's compensation can vary from product to product.  The advisor may have conflicts of interest, as he is motivated to maximize his compensation, and some of the factors that may impact his  fund selections can be unknown to you. The same applies to an advisor putting you into "managed money".

What you ideally want is some Poindexter managing your account who is an equities market junkie.  It may even be better if the advisor has lesser sales skills.  You want an advisor who does minimal cold calling, as he would rather be pouring over financial reports and examining charts.  Another benefit is that the client will become more educated about investments.  It is your option to learn as much or little from this process as you choose.  You will see the decisions that made profits for you and the ones that cost you money, and there will be both.  This is quite different from knowing your assets are in a "growth fund".

A truly independent investment advisor is the best model for a client.  The only compensation to the advisor should be the management fee, calculated as a percentage of assets under management.  The client should interact directly with the person who is making each intraday transaction, no third parties, no pooling of assets with other investors, your portfolio is uniquely designed for your goals.  The "advisor" is not someone who selected another entity to manage your funds and make the hard decisions that impact your life.

If you have made the decision to invest in mutual funds, you can and should only do so yourself. The fund companies have a staff that can assist you in allocating your assets consistent with your risk tolerance.  Unless you have a penchant for paying fees, please do not hire an advisor to purchase mutual funds for you.

Note: this article was written in October, 2006