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When I moved from London to New York City in 1986, I didn’t have a job lined up. But after a panicked search, I landed a position at Forbes magazine—as a so-called reporter, the title given to lowly fact-checkers. Almost two years later, I escaped that drudgery when I was promoted to staff writer and assigned the mutual-funds beat.
At the time, the fund world was a cesspool of dubious practices and misinformation, which was bad for investors but good for curious journalists. Here’s just some of the nonsense that was regularly spouted by stock brokers and fund-company executives:
“Don’t worry about fund expenses because they’re already reflected in returns.” What about the notion that fund expenses are the biggest driver of relative performance within any one fund category? That idea was rarely discussed, even among fund cognoscenti.
“Load funds perform better.” There was no proof for this, and yet brokers regularly repeated this lie.
“To find funds that’ll outperform the market, start with those that have strong five- and 10-year records.” Even though the warning label said past performance was no guarantee of future results, almost everybody—including me—assumed historical returns did indeed foretell the future. Even today, many folks rely on past performance when picking funds. It’s perhaps the most enduring mutual-fund myth.
“If you want good results, don’t constrain what fund managers can do.” In the late 1980s, investors started questioning the high portfolio turnover at some funds, or how they made big taxable distributions, or how some managers bought pretty much anything they wanted, rather than following a consistent investment style. This was dismissed as foolish talk that would result in poor fund performance. Today, by contrast, fund managers are more carefully monitored—because it’s widely acknowledged that high turnover and tax inefficiency hurt fund investors, and that style drift can result in investors owning funds that are radically different from what they expected.
“You buy the fund, not the fund manager.” The late 1980s saw the rise of the star manager, notably Peter Lynch. But in 1990, Lynch retired, while other star managers started jumping ship to competing money-management firms, where they could earn bigger paychecks. To slow the resulting exodus of investors, fund companies would claim a fund’s record should be attributed to the fund, not the manager, and would cite things like the firm’s research department or its culture. All this was disingenuous: Many fund companies would cheerfully publicize their best-performing managers—right up until they left.
“When fund investors are buying, it’s time to sell.” Long scornful of everyday investors, stock brokers and other Wall Street denizens would chortle about the ineptitude of mom-and-pop investors, and how they always tended to buy and sell stock funds at the wrong time.
As I’ve often noted, Coca-Cola and Ford Motor don’t belittle their customers, and yet Wall Street employees have no such qualms. Is their scorn justified? Yes, many amateur investors end up lagging far behind the stock-market averages. But that’s also true of many professional money managers. Should we also heap scorn on them?
I am currently reading John Bogle’s Common Sense on Mutual Funds 10th Anniversary Edition (2010) which you, William Bernstein and others commented in the praise for section of that book’s introduction.
In the book Jack Bogle wrote –“The great paradox of this remarkable age is the more complex the world around us becomes, the more simplicity we must seek in order to realize our financial goals.” which also seems to be a guiding principle in your thinking.
You wrote “Jack Bogle cares passionately about everyday Americans-and that passion is palpable in these pages.” I feel the same about your writings. Thanks for sharing your thinking.
Best, Bill
Jack is probably the person most responsible for mutual funds’ low expense ratios, and since we know that is one of the greatest drivers of portfolio returns, the enrichment of millions of investors.
Perhaps we should “heap scorn” on professional money managers–at least the ones who still engage in questionable behaviors.
Thanks Jonathan for an enlightening article.
“Don’t worry about fund expenses because they’re already reflected in returns.”
I often read about investors putting money into Closed End Funds (CEF’s) which come with high expense ratios (ER), but with higher dividend yields. They say the ER is baked into the dividend, but I’m a skeptic and avoid them altogether.
Today, almost all mutual fund companies (and perhaps all) first deduct annual fund expenses from the investment income that each fund receives, and then if necessary collect the rest by selling fund investments. But in the early 1990s, I recall that two fund companies recouped their expenses solely by selling fund investments. That allowed their funds to tout a higher cash payout. This, of course, was scummy behavior: The higher cash payout meant their funds were less tax-efficient, plus the higher cash payouts came at the expense of a shrinking share price, which presumably the funds hoped naive investors wouldn’t notice.
Such shenanigans were common at the time — along with minnow-eats-whale fund mergers to kill off bad fund records, quarter-end and year-end window dressing, tricks to inflate yields and more.
Appreciate that extra bit of information!
After reading Arthur Levitt’s book Take On The Street 20+ years ago, I once brought up window dressing to the rep at my brokerage and got the deer in the headlight look. She had no clue what I was talking about.
By the way, I’ve just started reading My Money Journey.
Many of the things you mentioned persisted into the early 2000s when I was briefly in the business. This is a good example why regulations such as fiduciary standards exist.
It’s easy to take good information for granted, and forget the contributions of writers, such as you, who raised the level of knowledge of the average Joe investor to where it is today.
It brings to mind a sales call to our home from a affable old gentleman who had once been part of a mutual fund multi-level marketing business. He said he had been called out of retirement for this new company, but was using his old sales material to convince my wife and me to move our money into his load funds. He said they performed better than the ones we owned and quickly ran through some numbers to prove his assertion. I knew something didn’t look right, but couldn’t put my finger on it while he was sitting there.
After he left, I took a closer look at the figures from the sources he had quoted and realized he was flat-out lying, apparently counting on our ignorance. He wasn’t far from wrong, but he taught us a good lesson about the snakes in the business, and left us wiser than he found us.
Hmm., I don’t want to say the name of the outfit, but I think it begins with the letter P.
Interesting, Dan. I don’t know much about the different firms but I always remember my husband saying, “If something ever happens to me (which it did), don’t ever give money to this firm (pointing to a local office),” and it began with a “P,” so I have steered clear.
I was thinking along the lines of the door-to-door peddlers and hold special meetings at shady restaurants begins with the letter E.
I knew of the MLM business, because they had a building in Jacksonville in the ’70s and 80s, and I had some friends involved, but I can’t recall the other. I was surprised, because the referral came through a network of financial service providers from a source that I thought was reputable. But the education only cost an evening of time, however, since we didn’t spend any money.