The Real Value Of Mutual Funds Over Time

In a post a little while back I lamented that the deck is kind of stacked against us these days when it comes to being financially responsible.  Whether it be the endless gadgets that are one click away or increasingly oversized homes, there are just so many more ways to overspend these days as compared to even 20 years ago. 

Throw social media into that mix with its comparison and jealousy games and you have a nasty, volatile cocktail of financial distress and ruin. 

But I also mentioned the numerous advantages we now have to help us manage and grow our money.  And perhaps the most significant of all of these advantages is the mutual fund. 

In October Vanguard issued an eye-opening research paper titled “What is a Mutual Fund Worth?” that shows just how valuable these investment vehicles have been to us collectively over time.  It’s important to remember that although the fist modern mutual fund was launched in 1924, they were mostly unused and obscure until as recently as 1980. 

As Vanguard details, in 1980 mutual funds constituted only 6.2% of household exposure to the stock market.  And remember that’s of the small minority of households that had any exposure to the stock market at all.

We’re Getting Our Money’s Worth

Diversification reduces risk, as any amateur investor understands.  What Vanguard attempted to quantify with their research was the actual financial benefit we as collective investors have reaped from the diversification that mutual funds provide.  But what has that actual risk reduction been worth from a historical perspective?

Trying to quantify something like this seems daunting.  In essence they’re trying to whittle down complex personal decisions about money – specifically the risk/reward decision between buying individual stocks versus a diversified mutual fund – to a number. 

To do this they had to make certain assumptions about investor risk tolerance and behavior. They also used actual data of the average household exposure to individual stocks and mutual funds for the analysis.  You can dive into the paper to find out what those are, but from my perspective their methodology appears rigorous enough to be relevant. 

It gets a bit dorky and mathy, so read it at your own risk.  They used a “utility function” and a “risk-aversion coefficient” in a spiffy equation.  So what’s the takeaway? 

Well, according to Vanguard’s analysis the shift from owning individual U.S. stocks to owning U.S. stock funds over time has produced $731 billion in investor benefits.  And as they point out investors pay way less, sometimes nothing, to secure this benefit. 

Here are the two key charts from the report:

And remember this analysis includes both actively managed mutual funds and index funds.  We smarter investors know that even the brightest and most educated portfolio manager cannot beat the market year over year on average, so we use index funds. 

Not only do they tend to outperform actively managed funds, they cost way less on average because computers don’t buy 8 bedroom mansions in Connecticut and expensive cars. 

A Transformative Technology

A great time to be alive and an investor

This analysis from Vanguard only quantifies the massive gains in wealth we investors have benefited from because of the game changing diversification offered by mutual funds.  In the report they state “Mutual and exchange-traded funds have been a transformative technology.” 

Their report doesn’t even go into the many other great wealth-building tools we have available to us today such as 401ks, IRAs, and HSAs to name a few.  It really is awesome when you think of all the great tools we have that our parents or grandparents didn’t.  

The way I see it, if you are disciplined with your money and avoid lifestyle inflation, this is an amazing time to be alive as there are so many tools and options to use to become wealthy.  On the other hand, if you spend all of your money and fall victim to consumerism and lifestyle inflation, these tools will do you little good. 

If nothing else, mutual funds, index funds, and 401ks are probably widening the gap between the disciplined and the undisciplined.

When I see analysis like this with the eye-popping numbers, I realize what a great time this is to be alive! 

I’m so grateful that I was born when I was instead of 50 or even 30 years earlier.  The modern wealth building tools of today have helped me become financially independent and wealthy beyond my wildest dreams.  They’ve helped me semi-retire from my W2 career and start a great business.  They’ve given me piece of mind and security. 

I’m more stoked about life now than ever before. 

And for that I’m grateful.