Advising investors not to buy mutual funds, as we recently did rather publicly, is a surefire way to raise some people’s dander. Of course, most of the offended parties are in the business of selling or managing funds.
We stand by that rule though: Why would you want to buy something with high fees that continually underperforms?
Along the same lines of “what not to buy,” here are five other investment products you can do without next year, if not your whole investing career.
New closed-end funds
Every week, it seems, there is a new closed-end fund offering, giving investors the chance to participate in whatever is “hot” that week. These funds are designed to sell, and by that we don’t mean they are typically good products.
Nope, these funds are designed to pay high upfront commissions to move them out the door. Advisors love them as they typically pay between 3% and 5% to the seller. Roll in startup, legal and investment banking costs, and you hit the ground running with a net asset value of $9.30 per unit or so on a $10 IPO issue.
Under the cruel way math works, you now need a 7.5% return just to get your money back. Some of these funds are okay, really. But let another investor pay the upfront costs. Don’t be the sucker.
Market-linked GICs
Who wouldn’t want a guarantee on their principal and a market-based return? These GICs always sound great in their advertising, but some of the advertising can be misleading.
Some show total returns, not annualized returns like everyone else in the industry. Most have liquidation clauses, so if the market drops a certain amount, everything moves to cash and you get no return at all. These selling clauses force the exact opposite of what should be done when the market drops a lot.
But the worst thing are the high fees attached to products that are really no better than what investors could accomplish on their own, with far more upside potential to boot.
Very small ETFs
Most investors do not realize that, unlike a mutual fund, an exchange-traded fund does not need a unit holder vote if the manager wants to shut it down completely.
Investors get their net asset value back in this case, but a small ETF often trades in illiquid securities, so their realized amount may be much less than the stated net asset value once liquidation occurs.
Stay away from any ETF with less than $30-million in assets.
Leveraged ETFs
Do you want to double, or triple, your bet on oil, the market, gold or other assets? There is a whole range of ETFs are specifically designed to go up (or down) two (or three) times their underlying asset base or index.
If you’re right in your prediction, some ETFs can go up 10% or more in a day. But if you’re wrong, you lose just as fast.
What’s more, the derivative resets that these ETFs use cause your net asset value to decline fast even when you are right. Meanwhile, fees (typically near 1%) continually eat away at asset value as well.
These are gambles, not investments.
Companies with a market cap of less than $10 million
If you think mutual fund fees are bad, consider the fate of very small companies. It is estimated that the annual cost of being a public company is about $400,000. Just being listed can cost a $10 million company 4% of its market value every year.
Most companies of that size have little in sales, profits and cash. Thus, microcaps typically need to raise money on a regular basis just to stay listed.
The result: continual share dilution.
Consider TVI Pacific Inc. (TVI/TSX): It is larger at a $16 million market cap, but its share count has jumped to 655 million from 182 million in 2002. Its shares have bounced around from 1¢ per share to 36.5¢ in that time, and are currently 2.5¢.
Peter Hodson, CFA, is CEO of 5i Research Inc
