When are mutual funds considered a bad investment?

Mutual Funds
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June 2018

Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end and back-end load charges, lack of control over investment decisions and diluted returns.

High Annual Expense Ratios

Mutual funds are required to disclose how much they charge their investors annually in percentage terms to compensate for the costs of running investment businesses. A mutual fund's gross return is reduced by the expense ratio percentage, which could be very high - in the range of 2% to 3%. Historically, the majority of mutual funds generated market returns. Excessive annual fees can make mutual funds an unattractive investment, as investors can generate better returns by simply investing in broad market securities.

Load Charges

Many mutual funds have different classes of shares that come along with front or back-end loads, which represent charges imposed on investors at the time of buying or selling shares of a fund. Certain back-end loads represent contingent deferred sales charges that can decline over several years. Also, many classes of shares of funds charge 12b-1 fees at the time of sale or purchase. Load fees can range from 2% to 4%, and they can also eat into returns generated by mutual funds, making them unattractive for investors who wish to trade their shares often.

Lack of Control

Because mutual funds do all the picking and investing work, they may be inappropriate for investors who want to have complete control over their portfolios and be able to rebalance their holdings on a regular basis. Because many mutual funds' prospectuses contain caveats that allow them to deviate from their stated investment objectives, mutual funds can be unsuitable for investors who wish to have consistent portfolios.

Diluted Returns

Mutual funds are heavily regulated and are not allowed to hold concentrated holdings exceeding 25% of their overall portfolio. Because of this, mutual funds tend to generate diluted returns, as they cannot concentrate their portfolios on one best-performing holding.

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