Don't Monkey With Your Mutual Fund Advice

Plenty of people believe that mutual funds are such a simplistic investment that an educated chimp could pick a good one. But that doesn't mean you want to monkey around with that chimp's advice.

"Sammy, the chatting chimp" claims to provide "astute accounting advice" in his column in the Weekly World News -- the supermarket tabloid known for its extensive coverage of space aliens and Bigfoot -- but what he really does is give a voice to some common misconceptions about money.

Now I don't put too much stock in Sammy, and cynics would say that's because I'm trying to protect my job from a competitor. In reality, it's because the most simple of advice often advances stereotypes and misconceptions.

For proof, let's look at how Sammy answered a recent question from William Drake of Houston, who wanted to know, "What exactly are mutual funds, and do you think I should invest in them?"

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Sammy suggested that mutual funds "are what an investment company offers to speculators: A chance to buy 'shares' of their expertise in buying and selling. Right now, about 80% of mutual funds underperform the average returns of the stock market."

"If you have a whole lotta bananas to invest for the long term, they're a good buy," the chimp continues. "But if you only have a small amount of savings, put it safely in the bank for now."

Even if you don't put much stock in the Weekly World News' reports of Satan filing for bankruptcy or Bat Boy running from the law, Sammy's advice sounds about right, not much different than what you might get at the corner coffee shop or sitting around waiting for a haircut.

But I'm going to throw a monkey wrench into the chimp's logic, because little misconceptions can lead to big investment problems.

At their simplest, mutual funds offer diversification and professional management at a reasonable price. The fund's share price represents the value of its underlying assets, and its expense ratio is the price you pay for the expertise applied in running the fund. Talk to almost any industry executive who is not employed by a firm that runs funds used in market-timing, and they'll suggest that funds are for long-term investors -- people willing to ride out the bumps in the market -- rather than "speculators."

As for the percentage of funds beating the market, 80% is more of a bull-market leftover than a recent statistic, but the entire concept is just a bit misleading. One reason why some funds don't outperform the broad market is that they're not trying to, focusing instead on a small portion of the investment world.

Standard & Poor's measures the performance of funds against their appropriate benchmarks, and called the battle a stalemate in 2005. More than 55% of large-cap funds beat the Standard & Poor's 500 last year, and yet only one in four actively managed midcap funds were able to beat the S&P MidCap 400.

Over the past three years, the S&P 500 has outperformed 62% of large-cap funds, so Sammy is still pretty far off.

The lesson from those statistics is that you're buying an individual fund, and not a statistic, and that you either find one whose management style and fees make you comfortable or you choose a low-cost index fund and satisfy yourself with market returns.

While the statistical evidence clearly suggests that index funds win out over the average actively managed fund over time, not every investor can strap themselves to the rollercoaster -- the market index -- and enjoy the ride's ups and downs.

Of course, after telling readers how the average fund does poorly against the market, Sammy suggested that investors buy funds only if they have a lot of money.

That logic is a bit backwards. If you have a lot of money, you have a lot of options for how to invest it. You can easily diversify risks by pursuing many different asset classes, a strategy which should smooth out the ride regardless of market conditions.

If you have very little money and you keep it all in a bank account, you will have a tough time growing it into anything significant.

Indeed, mutual funds are an easy investment to understand, select and live with, but oversimplifying them leads to problems and misunderstanding. You're not "playing the market" when it's your cash in the game, so if you have simple questions go find answers from a reputable source, not someone trying to make a monkey out of you.

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