Chapter 12 The Costs of Being Active

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor. He said, “Look, those are the bankers’ and brokers’ yachts.”

“Where are the customers’ yachts?” Asked the naïve visitor.

—Fred Schwed, Where Are The Customers’ Yachts?, 1940

As we discussed in Chapter 10, returns to mutual funds are generally weaker than the markets they benchmark against, mainly because costs of tractions and expense ratios drag down costs. However, there is now a further issue with mutual funds, according to the recent research of Antti Petajisto, formerly of Yale University and now at Blackrock.1

The problem is this: The point of owning a mutual fund is paying a team of analysts to pick stocks on your behalf, but according to this research, a significant group of mutual funds are no more than “closet indexers,”2 closer to following the market than trying to beat it. This matters because not only are you paying a high fee, but you aren’t getting what you might expect. It’s a little like paying up for Gucci loafers and then discovering that the shoes you received are remarkably similar to a pair from Target.

The average mutual fund in the study had a fee of 1.29 percent a year, whereas a passive exchange-traded fund (ETF) that tracks U.S. stock can currently be held for as little as 0.05 percent ...

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