ShmoopTube

00:00

And finance allah shmoop what's the difference between mutual funds

00:05

and index funds The answer this guy or well this

00:10

team what do they do They manage the mutual fund

00:15

mutually together You know what nemo They make bets on

00:19

apple and amazon in crotchless tuxedo pants Dot com will

00:23

these bets or into teligent investments In the parlance of

00:26

the industry our elements oven actively managed fund The mutual

00:31

fund is active in that it buys and sells hoping

00:35

to be smarter than the market and find areas you

00:38

know where they're inefficiencies where investors are throwing out the

00:41

baby with the bath water so that they buy the

00:44

shares here a twelve bucks and hope to sell them

00:47

if they hit thirty bucks in two years when the

00:49

new products get released and people are going absolutely bonkers

00:53

for self velcro ing neckties or whatever and index generally

00:57

stands pat on the hand It's dealt throughout the course

01:00

of the year making only small tweaks to invested amount

01:03

so that the fund itself conforms to the structure or

01:06

rules it set out when it was created But there

01:10

are a few vital and insidious differences that should make

01:13

investors today very wary about investing in mutual funds or

01:17

any actively managed fund When mutual funds first became popular

01:21

the investing marketplace was kind of the wild wild west

01:24

that was the nineteen fifties and sixties and a savvy

01:27

fund manager could beat the market by five and even

01:30

twenty percent per year year over year It was kind

01:33

of a golden age of mutual funds and money flowed

01:36

into them But like all good things this market wrinkle

01:39

easy winds and the investing world had to come to

01:42

an end Why competition when there were only a few

01:46

mutual funds out there and a few private investors it

01:49

was relatively easy to identify baby bathwater things you know

01:53

diamonds in the rough Today there are literally thousands of

01:57

mutual funds With such massive competition performance relative to the

02:01

market has lagged dramatic In fact over a typical seven

02:05

to ten year holding period only a very small handful

02:08

of mutual funds beat the typical index fund investing in

02:11

the same or analogous areas of stocks or bonds It's

02:15

like one in twenty ever really beat the market and

02:18

it gets worse Mutual funds charge relatively large fees compared

02:21

With index funds whereas a typical index fund might charge

02:24

twenty basis points to manage your money that is twenty

02:27

cents for every hundred bucks you have with them for

02:30

year The analogous mutual fund My charge One percent or

02:34

more that's five times surprise for demonstrably no better investment

02:38

results and wait It gets even worse Mutual funds trade

02:42

stocks and bonds and other securities index funds rarely trade

02:46

or if they do it's a very small amount of

02:47

trading around the margin keeping index in compliance with its

02:50

legal charter But many mutual funds have turn over the

02:54

apple variety of like fifty eighty or even one hundred

02:57

percent Turn over means that a fund has sold the

03:00

stock to realize a taxable gain You know book a

03:04

profit by taking cash from selling the stock or to

03:07

realize a loss sometimes as well we'll each time of

03:10

fund transact It pays a commission to our friendly excellent

03:14

golf skilled brokers but more painful to most investors is

03:18

that in transacting the fund realizes taxable game So what

03:22

does that mean Well here's the math If your mutual

03:24

fund is up twelve percent given year when the market's

03:26

up ten percent it would be an absolute top of

03:29

the pyramid performance here For the fun of beating the

03:31

market by two hundred basis points would likely mean that

03:34

mutual fund was in the top forty right up there

03:37

with rina's latest it single So what is that awesome

03:41

performance after tax for the mutual fund Well if the

03:44

fund had traded like the typical one it would have

03:47

had turnover of about sixty percent of its assets and

03:50

half of those sales would get ordinary income tax treatment

03:53

think high rates of something like forty percent with federal

03:56

and state taxes combined for most and long term gain

03:59

of twenty percent for the rest Well the wealthy pay

04:02

higher taxes so we're rounding down the numbers here even

04:04

being conservative So if half of the sixty percent or

04:07

thirty percent of the gain of twelve percent which is

04:09

around four percent his tax at forty percent then take

04:12

away one point six percent from the performance to get

04:14

an after tax net result number Then after another thirty

04:17

percent tax at the long term gain rate of twenty

04:20

percent you'd have take away another point six percent so

04:22

in total you'd have to subtract one point six plus

04:25

point six or two point two percent from the twelve

04:27

percent humongous rock star year to net nine point eight

04:30

percent in after tax returns Nope not very exciting relative

04:34

to that index fund And yes there are differences here

04:37

even important ones But the bottom line is that if

04:39

a huge performance top two percent fun has results Not

04:42

much better and or maybe worse than just a basic

04:45

index funds Why does anyone invest in mutual funds anymore 00:04:49.487 --> [endTime] Well this guy

Full Transcript