Still the star of the game?

The romance between investors and mutual funds may be fading.

Average American investors may be losing some of their infatuation with mutual funds.

Rising expenses, sliding performance, and the lure of the Internet have started coaxing American investors away from their once-beloved mutual funds and into the arms of individual stocks.

The latter can be more profitable - and more risky - than funds, and the Internet has made them cheap to research and cheap to buy.

Mutual funds, of course, are hardly going away. They dominate the US investment scene, with their unique characteristics of broad financial market diversification and professional management. Some 50 million Americans now own mutual funds, often through company retirement plans.

But warning flags are nonethless flying for the $5 trillion dollar mutual-fund industry.

Inflows, particularly to domestic US stock funds, are slipping. More individual investors are opting to buy stocks directly rather than through funds.

And complaints about the pitfalls of mutual-fund investing are increasingly common.

In a hard-hitting new book, "Common Sense on Mutual funds," John C. Bogle, a pioneer and elder statesman of the industry, senior chairman and founder of the Vanguard Group, argues that the industry has moved away from putting shareholder interests first and is instead chasing dollars to maximize profits for management. (See story, right.)

Still, anecdotal evidence suggests that there is some stirring under way among the ranks of shareholders. Redemptions at several fund families have been pronounced in the past year. And investors seem more willing to call up both fund companies and newspaper business pages to challenge lackluster performance.

Pulling out his money

Case in point: George Gregg, a retiree living in Scottsdale, Ariz., with his wife, Gini.

Mr. Gregg says he is frustrated by the dismal returns and lack of communication from his main fund company.

Last year sorely tested his patience. While the Standard & Poor's 500 Index shot up into the 20 percent range, several of Gregg's funds posted virtually negligible gains.

In trying to talk to someone at the fund offices, Gregg says he was never able to get through to anyone of importance.

As a result, he decided to cash out the sizable amounts he has in several of his funds, despite the stiff capital gains tax he will incur. He plans to shift the monies to Vanguard Group, in part because of its low expenses.

He also began toying with the idea of buying individual stocks. (He has just purchased shares in America Online.)

Gregg is far from alone. The number of individuals buying shares directly, rather than relying on mutual funds is on the upswing - a fact acknowledged by some discount brokerage houses such as Charles Schwab, which sell both funds and individual stocks.

At the same time, monthly inflows into stock funds have slipped, now averaging around $10 billion, down from the $20 billion range in 1997.

The complaints

The main reasons investors are dissatisfied with the fund industry:

*Few funds beat market averages. So far this year, of the 3,614 diversified US stock funds tracked by research firm Morningstar Inc., Chicago, only 951, about 26 percent, have beaten the S&P 500. About 74 percent of the funds fall below the index.

Yet that's just the tip of the iceberg. For the 12-month year ending April 30, only 15 percent of all funds beat the S&P 500.

In addition, slightly more than one-third of all stock funds now underperform the 4 percent return investors could have earned from a money-market account.

*Initial investment levels continue to climb, locking out many first-time investors.

*Expenses keep getting higher. Mr. Bogle argues in his book that selling fund shares to investors has taken priority over managing their money.

He notes that expenses have risen some 50 percent in just the past 15 years, from 0.97 percent of assets in 1981, to 1.55 percent in 1997.

Granted, many fund groups are lowering selected fees, among them industry-leaders Fidelity and Vanguard.

Still, investor outlays are massive. Shareholder costs have risen from $320 million 15 years ago, according to Bogle, to over $34 billion - a 100-fold increase that far exceeds the 70-fold increase in fund assets during this period.

*Indifferent management. Bogle, for his part, believes fund companies no longer look out for shareholders. Mutual funds have independent directors, but they tend to side with management, he says.

Argument for stocks

When high costs and dismal earnings are added up, there is a compelling case for buying stocks directly rather than via mutual funds, says Peggy Farley, who heads up investment firm Ascent Asset Management, in New York.

Ms. Farley concedes that as an investment manager she profits by having individuals buy and sell stocks. But many of the most attractive features that once characterized the mutual-fund industry have begun to disappear, she says, including liquidity (in some cases, investors find it difficult to bail out of a fund) and reasonable fees.

Moreover, disclosure is a genuine problem, she says. Shareholders, far too frequently, can't even find out "what's in their fund's current portfolio," she says.

Still, consumer experts say that owning a mutual fund can be a wise choice, especially for small investors who don't have access to expensive money managers.

To buy into a fund, "you must do your homework," says Herbert Ringold, author of "The Real Truth About Mutual Funds." Ringold is a strong proponent of funds. But, he says, you have to remember that even in the mutual-fund world, "there are a lot of bad guys out there."

So, he says, shop around. "Know what you are buying and why you are buying it."

You've read  of  free articles. Subscribe to continue.
QR Code to Still the star of the game?
Read this article in
QR Code to Subscription page
Start your subscription today