The Pirates of Manhattan (A follow-on from Investing vs. Speculating)

 

“The trouble with mutual funds is they are rewarded for the money they attract, not for the money they earn.”- George SorosAnother way to identify a financial scheme as speculation (as opposed to investment) is to determine the amount of compensation that goes to the individuals or institutions sponsoring the scheme. The more the sponsor gets paid, or the more that the compensation for the sponsor differs in comparison to the way investors are rewarded, the greater the likelihood for speculation being the true lot of the “investors.”

Remember, just because some financial scheme is classified as a speculative program doesn’t make it immoral or evil. But as mentioned previously, speculation requires different forms of evaluation, and a different set of expectations. And from my perspective, mutual funds are the biggest and most pervasive vehicles for speculation available to the general public.

For the past decade, I have made the generalization that mutual fund shareholders are not really investors, but simply “savers with risk.” I make this statement because the only control mutual fund investors can exercise over their investment is whether to be in or out. If you’re in the market as a mutual fund shareholder, you are simply along for the ride; somebody else is driving, no one has a map, and where you’ll end up is a guess.

The financial media tries to portray the fund managers as “trained experts” that understand the stock market. That’s a myth. Daily evidence tells us that their supposed expertise is easily overridden by an infinite number of financial, political and natural events. And while their specialized knowledge of might provide some hindsight perspective on why things happened in the past, the reality is that past events are not a reliable indicator of the future. (And every mutual prospectus makes this perfectly clear.)

Since the tongue-in-cheek dart-board stock picking contests often do as well as (or better than) the experts, it’s possible to conclude that the primary function of a fund manager’s “expertise” is to convince you that while neither one of you knows where you’re going, you should let him drive.

The best way to make money in mutual funds is to be part of fund management. Regardless of performance, guaranteed management fees are built into every fund. Whether the fund increases or decreases in value, management gets paid, and the pay scale for mutual fund management is astonishing. Your investment in the fund can lose money, but the managers still get paid. And if the fund does well, they get paid even more.

In his new book, “The Pirates of Manhattan,” author Barry James Dyke provides a detailed account of the jaw-dropping levels of compensation top executives at mutual fund companies receive. In a chapter titled, “Never Met a Man who Made His Millions in Mutual Funds,” Dyke makes a strong argument that mutual funds are a “sucker’s game” in which the individual investor never makes as much as management – while taking all the risk.

 

Dyke quotes Addison Wiggin and William Bonner from their book “Empire of Debt:”

“The scene would be depressing if there weren’t something gloriously comic in it. Wall Street is doing nothing evil; it is merely doing its job – separating fools from their money.”