Mutual Funds Vs Managed Accounts

There are some major differences in costs and efficiency between mutual funds and managed accounts that may have a meaningful effect on your investment returns.

Mutual funds are pooled funds, meaning all the money that you and thousands of other investors send to the fund company will be put into one large pool of money and the manager will manage this pool. If an investor wants to add new money or take out some money, it goes into and comes out of this pool. A managed account on the other hand is a private account, meaning that you have your own separate account which is not commingled with other accounts.

There are three main cost components in a mutual fund:

1) internal expense ratio-the incidental day-to-day expenses of the fund like the utility bills, rent, salaries, research etc.,

2) marketing, loads and 12b-1 fees that are incurred in marketing the funds and

3) transaction costs. These typically add up to anywhere from 1% to 3% or more annually for any mutual fund, even so-called “no load” funds. A great resource is John Bogle’s definitive bible called Bogle on Mutual Funds.

Managed funds typically can be had for 1% to 2% all-in if you can show your broker that you know the ropes. Much less if your accounts go into the 7 figures. With mutual funds, you are stuck with the common expense ratios no matter how much money you invest.

The most crucial difference to me is the efficiency factor however. If you picture yourself as the manager of a fund, you will be looking at valuations and buying when things are cheap, ie. when the markets are down, and selling when things are expensive, ie. when markets are up. Unfortunately, most fund managers are forced to do the exact opposite because of a phenomenon knows as the Small Investor Effect. The theory-and proven fact-is that the typical investor buys funds when the markets are doing well and sells when they are not. The Fear & Greed effect in action. That would be OK to us except that this activity puts the fund manager in a bind and forces him to sell when the markets are a buy and buy when the markets are a sell, effecting us all as shareholders. Separate or managed accounts were invented partly for this reason and in theory, they avoid this serious drag on performance-as long as we trust the manager to do his thing and not interfere with our own fear and greed impulses.

Most of the time, managed accounts are the way to go if you meet the minimums required, typically $50,000 to $100,000. Many mutual fund managers also have their brand private or managed accounts. There are times however, when a mutual fund is the right choice. A 401k plan or an IRA where you are adding fixed amounts periodically would be a good example because you cannot do that efficiently in a managed account.

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