Do the benefits outweigh the costs of investing in mutual funds? While investors may assume that picking any old mutual fund is a good decision because they are already highly diversified by nature, the short answer is that it varies dramatically depending on the fund’s individual expense ratio and performance relative to the market.
NerdWallet Investing analyzed over 13,000 of the largest mutual funds currently open to new investors in order to find out the worst 12 mutual funds in the industry suffering from both highest costs and worst performance overall. The lesson: investors should think twice before assuming that all mutual funds are a smart investment.
When you take into account both performance and expense ratio, these 12 funds rank among both the most expensive and the worst performing in the industry – eating away at your returns over time. NerdWallet Investing identified the mutual funds that are not only underperforming the market over time in their respective categories, but they are also charging far more in fees, as a percent of your total returns, than the average mutual fund.
As you can see, all of the funds listed above are actively managed, besides the Rydex Inverse S&P 500 Strategy Fund
(MUTF:RYUCX). Do the returns generated by actively managed mutual funds usually outweigh their costs? No, a recent NerdWallet Investing study
found that though actively managed funds earned 0.12% higher annual returns than index funds on average, because they charged higher fees, investors were left with 0.80% lower returns.
Worse Than Their Peers By Category
Even in categories that performed rather weakly over the past five years, the dozen funds listed above significantly underperformed their peers. This table shows how the above funds’ broader categories did:
By examining the wide world of open-end mutual funds, we were able to compare, contrast, and discover the worst performing funds over the last several years, which also charge unnecessarily high fees.
What Makes This Dirty Dozen So Bad?
Though one could calculate the "worst" mutual funds in a variety of ways, this study looks at two of the most important determinants of overall returns that an investor should be paying attention to:
Expense Ratio: It’s important that investors look at a fund’s expense ratio as listed in its fund prospectus or annual statement to get a sense of overall fees. All of the funds listed above have an expense ratio over 2%, which is outrageous considering that is the typical fee for hedge funds.
5-Year Annualized Return: Investors should look at a fund’s returns history over a longer term period, not just the last couple days or months, to gain a true sense of past performance and whether the fund was able to consistently outperform the market. Know, however, that past performance does not guarantee future results.
Better Ways to Pick The Best Mutual Funds
Risk-Adjusted Return: The volatility of returns should also matter to investors, so a high risk-adjusted return is smart to look for as well.
For investors looking to invest in top performing funds, NerdWallet Investing provides these tools to help you find them:
NerdWallet Investing launched a mutual fund screener to aid investors looking to find better mutual funds and ETFs for their portfolios
NerdWallet Investing’s 401(k) fund selector lets investors compare, contrast, and rank the funds offered in their company’s retirement plan
These resources help casual investors to find the best performing and lowest cost funds.
NerdWallet Investing analyzed all mutual funds and ranked them both by the expense ratio each fund charges, as well as each fund’s performance history over the last five years. Of the open-end mutual funds with a net expense ratio greater than 2%, the funds are ranked according to their 5-year annualized return in order of least to greatest. The dataset examines all funds that are open to new investors with at least $125 million in net assets, which have been in business at least five years as of March 4, 2013. It does not include any money market funds or exchange-traded notes.
Editor's note: This story by Susan Lyon originally appeared on NerdWallet.
To read more from NerdWallet, see:
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How to Find the Best REITs and Real Estate Funds
Breaking Down Annuities: What They Are and How They Work
No positions in stocks mentioned.