ETFs vs. Mutual Funds for Retirement: Part II

Mutual funds can help smaller investors diversify but there are several drawbacks for high net worth investors. For starters, they may not be as cheap as many investors think. Some fees can even be higher than what you would pay for true active management. Second, the strategy isn’t customized at all to your specific situation. Each fund has thousands of investors and you have no way to contact the manager and discuss your specific time horizon, cash flow needs or return expectations. In fact, if you own multiple mutual funds (which most mutual fund investors do) one manager could be buying a stock the same day the manager of your other fund is selling it. How does that lend itself to a coherent strategy?

Also important to realize is investors tend not to reap the benefit of even high-performing funds because they sell in and out of them too quickly and opposite the direction of the market. There’s a tendency for investors to pile into mutual funds when the market is high because they want to get in on the action and sell out when the market dips because they’re fearful. This is a classic buy high; sell low mistake—the opposite of what you want to be doing. The chart below shows when investors get into and out of mutual funds.

Note investors started to jump back in as the market rose through 2013 and got out in periods between 2009-2012 when they would have been well-served to be invested and riding the market up.

So how hard is it to stay invested? DALBAR, a market research firm, studies this in its yearly analysis. Based on the last twenty years ending in 2012, the average holding period for the average equity fund investor was just 3.3 years*—a piece of a market cycle (about half an average-length bull market).

Monthly Net Equity Mutual Fund Flows

a chart of monthly net equity mutual fund flows.

*DALBAR, Inc., Quantitative Analysis of Investor Behavior, 2013.

Takeaway: Mutual funds can be good for smaller investors, but can have drawbacks for higher net worth investors. The choice between ETFs for retirement or mutual funds should be carefully considered.  Investors should understand the differences between ETFs and mutual funds for retirement before making any decision.