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Funds of Funds: Higher Expenses Means Trouble

Given that there are currently more mutual funds than there are stocks of actual companies, it’s no surprise that some ivestment managers have decided to make a living by creating portfolios of funds rather than stocks.

Funds like this have historically shown to have an even lower chance of beating the market than other actively-managed funds. Why? Two layers of expenses. (To pay for both the underlying funds as well as the fund whose job it is to choose among them.)

Grand total costs of these actively-managed portfolios of other actively-managed funds often approach 3%. That’s a big portion of return that they’re eating.

Passively-managed funds of funds

Other funds of funds are simply passively-managed portfolios of funds run by the same company. They own shares of their own company’s funds, and buy/sell them at predetermined times (to maintain a given asset allocation, for instance.) The most common funds in this category are the “target retirement” funds.

Many of these funds are acceptable choices, because the only expenses being charged are the expenses for the underlying funds. (And this makes sense given that these funds only invest in funds run by their own company, so there should already be a built-in profit margin.)

Unfortunately, however, several target retirement funds do actually charge an extra level of expenses. In this scenario, you’re essentially getting the same funds that would be available to you anyway, but you’re paying more money for them than you need to.

Overall lesson: Before investing in a fund, be sure to take the time to actually read its prospectus (or, at least, the part of it that describes the investment costs). It’s important to at least know what you’re paying.

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