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  • Rohit Musale, CFA

The 10 Reasons Not to Invest in Mutual Funds

If you have any kind of formal finance background, ideally, you are better off, not investing in a mutual fund.


Because, it doesn't take a genius or a high IQ, to pick investments on your own.


Mutual funds are a great product for beginners or non-finance people.


But not for you, if you understand the basics of money and capital markets.


Here are 10 reasons not to invest in a mutual fund:


1) They are middlemen


They will eat away at your overall annual returns.


Why would you give your money to someone else to manage, when you can do it on your own?


2) The fund manager's interests are not aligned with yours


What do you think the fund manager is more interested in?


Retaining his job as a fund manager?


Or trying his best to grow your wealth?


It doesn't matter if you make money or not.


The fund manager will get his salary.


The fund house will keep charging fund management fees on the assets under management.


3) Mutual funds are in the asset gathering business


There are a lot of money-management businesses in the world, that have deliberately chosen to remain small, in terms of assets under management.


They truly want to be in the asset management business.


They don't want to be in the asset gathering business.


Which business do you think, the mutual funds are in?


Asset management or asset gathering?


As I said earlier in one of my blog posts, 'If you do not understand the game, the game will be played on you.'


Always remember that statement.


'If you do not understand the game, the game will be played on you.'


4) Fund managers won't beat the market indices


In the short term, yes.


Some fund managers can show success.


However, over very long periods of time, the chances of the fund manager beating the market index, is very low.


There is a lot of research done on this.


Beating the index is a game, that is best played, by avoiding it altogether.


5) You have no control


You invest in a fund.


You check the portfolio holdings.


It has a company, that hasn't made a dime in the past 10 years.


Meaning, it has no ability to generate a free cash flow.


What can you do about it?


Can you call up the fund manager and say, 'Please remove this company from the portfolio.'?


You really can't do much about the situation, other than getting rid of your mutual fund units.


6) Your favorite manager calls it quits


You invest in a fund, because you like a particular fund manager.


What if he quits the company?


Are you going to sell your units?


Are you going to move your funds to where the fund manager is going next?


Wouldn't selling your units incur an unnecessary tax liability for you?


Why would you have to pay tax, just because your fund manager quit the company and is joining some other asset management business?


In such a scenario, to avoid paying taxes, you will have to settle for some other fund manager, whom you might not know that well.


7) The inability of mutual funds to sit on cash


Mutual funds cannot remain on cash for too long.


Eventually, they have to deploy the money as per their mandate.


Whereas you, on the other hand, can choose to sit on cash for years, until your favorite company reaches a reasonable valuation, where you now feel comfortable getting in.


That, by the way, is the method used by the most successful investors in the world.


They operate with extreme patience.


8) The fund manager cannot speak the truth


Imagine, the economy is crashing.


The central banks are raising rates.


Asset prices are under pressure.


Is the fund manager ever going to say, 'The market is going to fall in the coming years.'


If he does that, he will face redemptions in his fund.


So, even if the fund manager is super-bearish on the market, he can't speak his mind out.


9) Your fund manager cannot invest in almost any company


You, as an individual investor can invest in any company in the stock market that you want, be it a blue-chip company or a penny stock.


The fund manager can't do that.


He is supposed to follow a mandate.


Even if he likes a particular small cap company, he can't deploy funds there, since he has been given a mandate to invest only in large caps.


Yes, you can choose both a large cap and a small cap fund for your portfolio.


But that will force you to take an exposure to other small cap companies in the portfolio, which you may not want to invest in.


10) The fund manager cannot react quickly to bad news


You as an individual investor can simply choose to close all your positions and stay away from the market, if you predict something really bad happening in the future.


Your fund manager can't go to 100% cash in a single day.


The funds have to remain invested as per the mandate. As long as that is done, the fund manager's job is safe.


So, those were the 10 reasons I wanted to discuss.


Mind you, I am not saying, don't invest in mutual funds.


All I am saying is that, if you come from a formal finance background, and if you understand the game of money, you are better off, not outsourcing your money management to someone else.


Do it on your own.


You are likely to do well.


Because, you will have more flexibility.


Regards,


Rohit Musale, CFA


29 December 2022

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