Review: Is Your Mutual Fund Hiding in the Closet?

When you buy something, you should get what you pay for. This is true no matter what you are buying, especially with investments. Investing is already confusing enough for most people – you shouldn’t have to worry that one of your fund managers is deceiving you.

To be clear, I would be surprised to find out that any publicly available mutual fund was actually lying. There are too many checks and too much money at stake for anyone to do something that stupid. But fund managers don’t necessarily need to make the information you want easy to understand.

One of the big ways this pops up is with closet index funds. These are funds that hold themselves out as actively managed (and charge like active funds), but are really just index funds.

The fund may look like an index, but the result is the same. You could easily be paying much more than you should. If you’ve read pretty much anything we’ve written in the past, you know we are not fans of active funds. They’re expensive, they can often mean a higher tax bill, and they just can’t consistently deliver on their promise of beating the market.

But if you want to use an active fund, you should get an active fund. Active managers should be making big calls and saying what the market will do next, not charging you 1% of your assets every year to slightly tweak IBM’s weight in their portfolio.

There’s an easy way to avoid this, though. Just skip the closet indexers (and all active managers for that matter), and use passively managed funds. You know what you’re going to get, and you can use that to build a portfolio specifically tailored to your risk preferences.

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