Rich Getting Richer?

I came across an interesting financial column today which argues that mutual funds are lousy long term investments. The author, Robert Kiyosaki, writes a column for Yahoo! called "The Rich Get Richer", and he seems to be some sort of professional real estate investor and self-proclaimed "rich guy". I guess as someone who is rich he feels that he has earned the right to lecture the rest of us on getting rich, too. His articles seem to be a cross between Dale Carnegie (folksy, pragmatic storyteller) and Donald Trump (money-hungry real estate mogul), and he appears to have some strong opinions about the validity of some widely-held investment beliefs. Feel free to read some of his other articles to get a taste for his mindset.

[Note: It appears as if he is also the author of a best-selling book called Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money--That the Poor and Middle Class Do Not!. The title is vaguely familiar as being one of the many "pop-finance" books that graces the shelves these days.]

As someone who has been educated in the value of mutual funds, the efficient market theory, and the advantages of diversification, this article had me shaking my head violently. However, after my initial reaction, I started to think about his words, and I found that there is some truth to his assertion.

The author's basic premise is that the ongoing fees charged by mutual funds greatly erode your earnings, while adding no value to your investment. After all, he continues, you are putting up 100% of the money and taking 100% of the risk, so why should the mutual fund company take any of your earnings away from you at all! He gives some cooked example of how the fund companies end up taking 80% of your earnings, but the numbers he uses don't seem to be realistic. It is probably more in the range of 30%, which is still a non-trivial amount, but nowhere near the panic-inducing number that he gives. Still, the question still remains as to what you as the investor is gaining from this transaction.

I think the key is to understand the distinction between what the author calls a "passive investor" and an "active investor". A "passive investor" doesn't have time or inclination to dedicate to investing, so he or she is quite willing to hand over the reigns to a mutual fund or financial advisor. Meanwhile, an "active investor" has the time and inclination to take a more active role in evaluating investment opportunities. In this other article, Mr. Kiyosaki seems to be making a value judgment on which type of investor is better. The "passive investor" is described as being ignorant, unfocused, and amateur. On the other hand, the "active investor" is just the opposite: knowledgable, focused, professional, rich, and successful. I think that this value judgment is what propels him to call mutual funds lousy investments. After all, when you invest in a mutual fund, you are admitting to the world that you are not focused enough to make your own detailed investment decisions, so you are willing to accept the crutch of diversification. In his eyes, this somehow makes you a lesser investor.

Personally, I freely admit that I am a "passive investor". Unlike Mr. Kiyosaki, I do not think that this term has negative connotations. If I wanted to become a "active investor", I would have to dedicate a lot more time and effort to such a task, and frankly, I would rather spend my time and effort in other areas of my life: my career, my family, my community. I do not want to spend my days chasing down investment opportunities, researching their pros and cons, and micromanaging my investment holdings. Being an "active investor" is a full time job, and while it may be more profitable than my current job, it isn't something that I would be enjoying.

That is what mutual funds are for. They are for people like me who understand that we do not have the time to do the research in order to gain a competitive advantage in the investment market. Instead we would rather give up some of our gains so that we can "diversify" our investments in order to compensate for our "ignorance". I am good with that!

One thing that I should mention is that I totally agree with his advice that if you ARE going to invest in a mutual fund, invest in a low expense index fund. Most actively managed funds end up underperforming when compared to a comparable index fund, so why pay extra fees for a smaller return? On that point, Mr. Kiyosaki and I agree.