Mutual Funds Bull's Rebuttal
by Rick Munarriz ([email protected])

Control. That seems to be a sticking point with my friend and Fool on this issue. It makes me think about how much control one really has in the stock market. Just like buying a stock, one buys a mutual fund because one has faith in management and expects the vehicle to be a relative winner. An investor does not know the day-to-day happenings at a company or a mutual fund. In both cases you get quarterly updates. Try as we will, we are forced to be passive investors in either selection.

Yet a proactive mutual fund manager, because of the significant stake he or she has in a company, can make things happen. Just look into what Michael Price has done to increase shareholder value at Sunbeam and Citicorp. Does the CEO of the company you own know you on a first-name basis? Does he or she fear you cashing out your position to the point of being an eager listener? Pauly argues that size hinders. I argue that size matters. Size wins you a hand on the steering wheel. Control? Please. Let's not confuse free will with control.

Pauly does hit on some solid points, but they are nothing that we can't tackle. Fund expenses? Unlike a stock, where you are in the hole by the sum of the commission and the bid-ask spread, in a no-load mutual fund all your money is working for you. Sure, the fund has expenses, but for your average $1,000 investment they run a little more than $10 a year. Think about it -- isn't that less than what you paid for your last stock trade? Or that month of Barron's?

Taxes? I've got three words to say to this. Eye, Are, Ay. In an Individual Retirement Account, or any other tax-exempt or tax-deferred investment, it is irrelevant. However, even if you are buying funds in a taxable account, a quick look at any fund prospectus will show you the average portfolio turnover in any given fund. If you are worried about taxes, just look for a fund that meets your needs with low turnover.

Paul is also concerned about overdiversification. He claims that large funds wind up buying too many companies. Last time I checked, the S&P 500 consisted of a whopping half a thousand stocks!

I will have to agree that I, too, am perplexed at how often professionals lose out to a dartboard. However, before you hand me a screwdriver to take off those training wheels once and for all, please understand that of those 91% of mutual funds that underperform the market, a whole lot are bond funds, balanced funds, etc. They were never intended to run like a Lamborghini through a school speed zone. In this giddy market we have ignored the inverse relationship between risk and reward. We have assumed the latter. We have forgotten the former. The cure for amnesia hibernates. When the bear eventually awakens, you might find that those who put vanity aside and accepted a little money management diversity with one of the many quality mutual funds out there will become the real all-weather winners.

Next: The Bear Responds