Why You Should Hate Mutual Funds

Remember after the 2008 meltdown when many people said their 401k turned into a 201k?

That alone should be one reason why you should hate mutual funds. But it’s not the only one.

Please don’t misunderstand me here.  I don’t hate all mutual funds…only a majority of them.

Why?

In a word?

Liquidity.

This became obvious to me back in October 1987 – the Big One – where the market fell over 22% in one day.  Today’s 1,400, 1,600 or 1,800 drops pale by comparison to the wreckage done on October 19, 1987.

Mutual funds not only got crushed back then, investors were unable to sell their funds for up to two weeks later when the markets were “restored to an orderly fashion.”

That was total BS.

You see, back then – and even more so today – mutual funds can’t dump stocks without causing more damage to the prices.

Example:  Let’s say a $150 Billion mutual fund has 2% of it’s money in one stock ($3 Billion dollars).  And for some reason the stock has fallen out of favor and experiencing a “nosebleed drop.”  The fund can’t all of a sudden dump that stock without further crushing the price.

So, what do they do?

They sit on it and/or try to sell smaller increments to provide liquidity.

Oh, and about that liquidity issue.  When investors want out of funds in large quantities, it forces the fund managers to sell stocks that they might not want to sell.

Why?

Most funds stay fully invested.  So, in a crazy falling market – and in order to raise cash – they’ll sell some of their winners while watching their losers go down even further.

It doesn’t make sense but that’s how it works.

Then they’ll play games by swapping some of their losers with other funds in their “family of funds” and hide losses in order to make it look like they had a good year.

Has this ever happened to you?  You bought a fund in September or October and by December it’s down 5, 10, or even 15%.  Then you get a report that the fund had a capital gain and you end up paying taxes to Uncle Sam on an investment that’s down 10% or more.

Ouch.

It’s another reason why you should be cautious with mutual funds…especially in your 401k.

We’ve been saying for a few weeks now that you should be raising cash while the markets have recovered from big losses earlier this year…especially in mutual funds.

Be sure to read out “Short and Sweet Tips” column in our June newsletter to see why.