4. Fees. Paying a skilled professional to exploit inefficiencies in the market sounds reasonable until you do the math. A front-end fee of 4.75 percent, not uncommon for an active fund, means you are only really investing 95 cents for every dollar. In effect, you are starting with a negative return. That fund manager must be able to deliver significant alpha (excess returns above the benchmark) just to get back to even.
And when you consider the higher expense ratios relative to passive strategies, the value proposition starts to look murky at best. Some managers might obfuscate the fee issue with discussions of risk, but the one rule that remains is caveat emptor.
I believe that many asset managers today are using high-fee, actively managed mutual funds as tools to enrich insiders. Repeated poor performance, unfair treatment of tax liabilities, high costs and other inherent flaws make most mutual funds a poor value proposition. Index funds and specialty strategies may be exceptions, and there are always a few managers with legitimate stock-picking skills. But it's virtually impossible to construct a portfolio selecting only top-performing mutual funds.
That's why there has been a fundamental shift in investors' thinking and behavior, which has been evidenced by the massive flows out of actively managed funds and into passive strategies.
We are still in the middle innings of this paradigm shift, but you don't need to be the last one out. Now may be a good time to consider building a portfolio around lower-cost, exchange-traded funds or index mutual funds, coupled with a customized selection of individual securities.
— By Bill Harris, CEO of Personal Capital