The case against Mutual Funds in RRSP

Here is a recent correspondence I had with a friend of mine and I thought it’d be helpful for those of you out there in the same situation. It consists of all my arguments against investing in Mutual fund in your RRSP portfolio. For Americans, it is the same argument for your 401k. Here they are:

Good idea. Well, you still got about 30 years ahead of you to compound at 5%. That is what RRSP is for. That and getting rid of under-performing stock in exchange for cash tax return. You want to invest in mutual fund or stocks outside of a registered account so you can claim the loss as tax credit.

The problem with fund managers is that only 25% of them beat the market over 5 years. Whereas only 50% of them beat the market every year. You can basically calculate the odds of them beating the market by doing a calculation of (0.5)^x where x is the amount of year you are looking at. So a mutual fund will need to do about 7% return per year in order to pay you 5% per year. Now 7% is an average return if you ask me. It is what the market average return is. So for them to give you 7%, they will have to have a return of 9%. Most mutual funds has about 25% in bonds (@3%), that means that 75% of their stock portfolio will have to generate 11% return (75a + 0.75 = 9 solve for a ) to get to that target of overall 9% return. What are the chances that someone can beat the market by 4% per year? Historically there are only about 10 of them who did it in their 50 years of investing since 1927.

Another thing I have also noticed is that they usually present you with a chart of percentage rises and fall instead of the actual price of the fund. This is to hide the fact that they are actually under performing. With 1000 invested, 10% loss followed by a 10% rise in the same fund does not equal to the original 1000. Any loss in a fund is bad.  Period. Another way to look at it.  A 50% loss needs a 100% gain to get back to the original value. What are the chances of it gaining another 100% afterwards? Mutual fund will always underperform everything else. Our Canadian Pension fund, is presided over by a board of directors who get paid 30 million a year in order to lose 30B in value. This is the problem we let others manage our own money.

Total market equity value will gyrate near the range of 1998 (and 2003) until around 2020. This is still a theory I am working on. I have yet to sit down and measure the data, but it’s a basic comparison of the Gross National Product (How much profit we make) vs the total gain in the stock market. Let me tell you, the stock market has been gaining a lot more than the GNP.  In the long run, GNP should be in line with the total market gain. I believe Jan 2009 we’ve fallen back to the norm. Now we are seeing fear driving it down. Which is why I got my Line of Credit.

That being said, depending on what your mutual fund holds, it might not be a good idea to get out now. Tech is the next boom and is surviving well. Housing is near bottom. Financial and traditional markets still has more pain to come.(Did I tell you that the peak of subprime is the year 2006? They have to refinance in 2009 and 2010) . Anyway,  there’s another dip in 2009 so if you can, get GIC for the year instead of putting it in the fund. You can always go back when it picks up in 2010.