Question: Why are there so many mutual funds?
Answer: Mutual fund management is profitable, so Wall Street creates more products to sell.
The large number of mutual funds has little to do with serving your interests as an investor. We use proprietary data to identify two red flags you can use to avoid the worst mutual funds:
1. High fees
Mutual funds should be cheap, but not all are. The first step is to compare what cheap means.
To ensure you pay average or lower fees, only invest in mutual funds with total annual expenses under 1.61% – the average total annual expenses of the 5,922 US stock funds we cover. The weighted average is lower at 0.89%, showing how investors tend to put their money in mutual funds with low fees.
Figure 1 shows that American Growth Fund Series One (AMRBX) is the most expensive mutual fund and Vanguard 500 Index Fund (VFFSX) is the cheapest. American Growth Fund (AMRBX, AMRAX, AMRGX) offers three of the most expensive mutual funds, while Vanguard (VFFSX, VSTSX) and Fidelity (FXAIX, FSKAX) mutual funds are among the cheapest.
Figure 1: 5 of the most expensive and cheapest mutual funds
Investors don’t have to pay high fees for quality stocks. American Century Capital Equity Income Fund (AEIMX) is the top rated low expense mutual fund. AEIMX’s neutral portfolio management rating and total annual expense of 0.06% give it a very attractive rating.
On the other hand, the T. Rowe Price Mid Cap Index Fund (TRSZX) holds weak stocks and deserves our very unattractive rating, but has a low annual total expense of 0.08%. No matter how cheap a mutual fund is, if it holds bad stocks, its performance will be poor. The quality of a mutual fund’s holdings is more important than its price.
2. Bad stocks
Avoiding bad holdings is by far the hardest part of avoiding bad mutual funds, but it’s also the most important, since a mutual fund’s performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each style with the worst holdings or portfolio management ratings.
Figure 2: Investment funds with the worst holdings
Morgan-Stanley funds appear more frequently than any other provider in Figure 2, meaning they offer the most mutual funds with the worst holdings.
Morgan Stanley Discovery Portfolio (MMCGX) is the worst-rated mutual fund in Figure 2. Morgan Stanley Insight Fund (MBIRX), Baillie Gifford US Discovery Fund (BGUIX), North Square Advisory Research Value Fund (ADVGX), Touchstone Sands Capital Select Growth Fund (TSNRX), Legg Mason ClearBridge Mid Cap Fund (LSIRX), ProFunds Small Cap ProFund (SLPIX), Longleaf Partners Fund (LLPFX), Bertolet Capital Pinnacle Value Fund (PVFIX) and MSS Series Footprints Discover Value Fund (DVALX) also earn a very unattractive overall prognostic rating, which means that not only do they hold poor inventories, but they also charge high overall annual costs.
The inner danger
Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business model and financials. In other words, researching mutual fund holdings is necessary due diligence, as a mutual fund’s performance is only as good as its holdings.
PERFORMANCE OF SHAREHOLDINGS IN FUND – FEES
Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Brian Pellegrini are not paid to write about specific stocks, styles, or topics.