The Mutual Fund Money Hole

Chris Mayer is winging his way to Australia with a few select subscribers as we write… but we suspect he’d chuckle at this news: 97% of all stock mutual funds are down from where they stood at the beginning of 2008.

According to Morningstar, the average stock fund rose 35% last year… but that wasn’t nearly enough to overcome the 41% loss the year before. (41%? The S&P fell only 38%!) Only six funds — six! — managed double-digit returns across the two-year span.

This brings to mind some timeless wisdom Chris imparted in the summer of 2008: “I’ve long held that mutual funds are full of bad habits, like a boy who can’t stop picking his nose and burping at the dinner table. If you had to design a poor investor, you need look no further than the typical mutual fund.

“For example, the typical mutual fund turns over its entire portfolio at least once per year and owns 160 stocks. These are two things that often lead to mediocrity: too much trading and too many stocks.

“All that churning fattens the brokers of the funds. And the funds often have unseemly arrangements to direct commissions to brokers who help market the funds. Owning all those stocks also means the fund managers often know little about what they own.

“No individual stock matters much, nor does any single issue make much of a difference, so why bother looking at any of them in detail? It is little wonder the typical mutual fund puts in such an indifferent result.”

The new numbers from Morningstar reinforce Chris’ thesis that you’re better off buying a small basket of stocks that meet his four basic criteria: priced cheap, in good financial shape, with a business model that’s easy to understand, run by managers who own a good chunk of shares themselves.

The Daily Reckoning