The Newest Investing Scam You Need to Know About

by Jason Unger

Investing Scam

There’s a reason why index funds are your best choices for investing:

  • they don’t try to time the market
  • they have low management costs
  • they own an entire segment of the market (or the whole market), so there’s no stock picking involved

This is not news. Study after study has proven that index funds are the best way to consistently grow your wealth investing in the stock market.

Money managers know this, too. Most of them can’t beat the index they’re trying to top, especially after the fees they charge you.

As more investors are switching to index funds, money managers are hopping on the bandwagon — but trying to charge their same, high management fees.

These new “closet index funds,” according to the Wall Street Journal, basically track the index, but are sold as actively managed funds in order to justify a higher management fee.

The pact between a mutual-fund investor and the manager of the typical stock mutual fund is, in theory, a simple one: payment in exchange for expert stock selection.

But financial advisers have long complained there are funds that don’t fully live up to that exchange. These funds charge high fees but follow a strategy that is very close to simply betting on an index. The supposedly active fund manager, in effect, is being paid for doing close to nothing.

Investing with a “closet indexer” is a double whammy for investors: It lowers their odds of getting results that are far better than the benchmark, which is a key reason to opt for an active stock picker (although, to be fair, their chances of falling far behind are lower, too). And they may be paying substantial annual fees, and sometimes sales commissions, for fairly average returns.

The Journal identified a handful of closet index funds:

  • Thrivent Large Cap Stock
  • Principal LargeCap Blend I
  • LargeCap Blend II
  • Dreyfus Fund
  • Dryden Large Cap Core Equity
  • First Investors Blue Chip
  • Nationwide Fund

There’s no beating around the bush here: this is a scam.

When you are being sold on the “expert advice” of a fund manager and they’re not doing anything a computer doesn’t already do for millions of investors, you are being cheated out of your money.

The managers may say that they’re trying to keep risk low by following the index, but this is not a legitimate excuse. There are plenty of options to do just that, and their costs are appropriate for the level of management they require.

Don’t follow the monkeys. Make your own investing decisions and know exactly what you’re paying for.

{ 2 comments… read them below or add one }

Phil December 30, 2009 at 11:07 am

Good post. You can quickly find the beta of a fund, which wiill tell you how much of its returns are a component of the overall market, exposing the close-to-one-beta funds are expensive index funds. ETFs offer even more transparency and higher *after-tax* returns than index funds.

Jason Unger December 30, 2009 at 11:21 am

Right on. Here are a few Betas of the closet index funds listed above:

Thrivent Large Cap Stock – .97 to S&P 500 TR
Principal LargeCap Blend I – .98 to S&P 500 TR
Dreyfus Fund – 1.00

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