New Financial Planner Starter Kit

Professional Investment Portfolio Building Kit

Their fancy expensive ad slogans aimed at financial planners used to say, "I can sleep well at night knowing my clients’ money is all in American Funds."

Financial planners ended up losing lots of sleep in 2006 after the press wrote about American Fund's underhanded dealings. They detailed how shareholders were being gouged, and how these ill-gotten fees were going right into the pockets of the BDs and advisors that sold them. Many American Funds shareholders called their advisors to complain. Fighting that off consumed most all of their time for over a month. So much for sleeping well. But the investing public went right back to sleep shortly afterwards.

Part of a Business Week article:

"Nor has American emerged from the fund scandals completely unscathed. It's under investigation by the Securities & Exchange Commission and the California Attorney General's office for allegedly making undisclosed payments to brokerage firms that gave it preferential treatment. American says it did nothing wrong. "We disclosed what was considered an acceptable level at the time," says spokesman Chuck Freadhoff. "The SEC saw our prospectuses and never raised the issue.

American uses that same matter-of-fact logic in its handling of the probes it is facing. Investigators are focusing on two kinds of payments made to brokers. In one, a practice called directed brokerage, the mutual-fund companies' funneled stock trading orders -- and fat commissions -- to brokerages that sell its funds. Federal and state investigators are also looking into revenue sharing. That's when fund managers rebate a portion of their fees to brokerages, based on how much client money that they put and keep in the fund family. The practice isn't illegal if it's disclosed. But it can encourage brokers to put their clients into funds that rebate the most rather than the ones best suited to their needs."

Their wholesalers (salespeople that travel around trying to get financial planners to use American Funds instead of other mutual fund families) are the best paid and supported in the business. They give out all kinds of freebies to financial planners when they "play ball." There have been reductions in this type of "schmoozing" over the years as regulations continue to tighten abuse. But it still goes on every day.

If they were to put these resources into actual money management, to have more asset classes, more funds, pay their managers better, and to get better long-term performance, then there wouldn't be much reason to complain. But most of it goes into marketing, sales, and into the pockets of Broker Dealers, wholesalers, and their salespeople. American Funds has the worse ratio of marketing fluff to actual beef of any mutual fund company.

Broker Dealers lead the parade with their cheerleaders waiving American Funds flags, and their financial planners usually have no choice but to be one of their floats. To be with the parade means one is rewarded in several ways. When one goes against the parade, they are punished in several ways.

Everybody wants to be part of the herd, with the program, and do what everyone else is doing because they think it's easier, more profitable, and safer. Less people in the world they live in are going to give "good soldiers" a hard time if they're going along with the program. So a lot of minor acts of misbehavior, mostly suitability issues, are ignored. Discretions that would have been prosecuted if the financial advisor used a different family of mutual funds are sometimes overlooked when compliance knows the deed was perpetrated using American Funds.

Back in the 20th century, there was a valid reason to use American Funds because they had the best customer service (most mutual fund purchases were done through the mail directly through the fund company). Their performance was a lot better too. These days, with the cost of technology so low, and thousands of American customer service and back-office jobs being outsourced to India, most all mutual fund families have similar customer service.

Also the service of a mutual fund family has become irrelevant since large custodians, like Ameritrade, Waterhouse, Bear Stearns, Fidelity, Schwab and Pershing, now hold most investor portfolios. This means when you want service, you get it from either the custodian, the salesperson or their staff, or their Broker Dealer. So even service is not a reason to buy American Funds anymore (mostly because nowadays they don't do very much).

American Funds has not had any real competitive advantage, other than self-perpetuation from the ignorant press and the slickest-looking market brochures, in the 21st century. They haven't been able to do one thing of any value better than competing families of mutual funds for a long time.

From the financial planner's point of view, that's working on a commission-basis, there are a couple of big advantages in using only American Funds.

First there's the "sales contest." Broker Dealers give all kinds of freebies to salespeople that sell the most. In some offices, there's even competition charts updated daily showing who's winning. The big prize is usually the annual lavish exotic winter cruise vacation in a tropical paradise. They call them "conferences," and it's where BD and wholesalers give out praise, applause, and prizes to the top sellers in a Hollywood Oscars-like setting. And don't forget the never-ending sales pitch about how to sell even more next year! Advisors that used more than one mutual fund family, because they want better performance for their clients, are left out because "those product sales don't count as much toward the quotas."

The flip-side of the sales contest is sales quotas. Financial consultants working on a commission basis have to drum up a minimum amount of brownie points annually, or they're fired. American Funds usually pay the most brownie points per dollar of sale, so they're naturally favored by financial planners working at the lowest levels fighting to survive.

Next, the Broker Dealer is usually more supportive, helpful, and efficient in maintaining a supply of American Funds prospectus, reports, paperwork, and marketing brochures.

When a financial planner recommends a mutual fund to a prospect (that pays a commission), they have to give them the current prospectus (and the latest quarterly or annual report) on the spot. These are updated frequently, so keeping the current version for every mutual fund used on hand in the office becomes a chore.

American Funds really only has 22 mutual funds. Most financial planners only use about six or less of those. So limiting their operations to several mutual funds from one fund family just makes their life a lot easier. Also reps only have to learn how to fill out one mutual fund family's paperwork, and sell from one set of sales brochures. If investment advisors had to stock their shelves with prospecti from every well-performing mutual fund family they use, it would be "too much work."

That's right, one of the biggest reasons why American Funds are the best solution to everything, and why investors realize mediocre investment performance, is because their advisors are just too lame to do a couple of extra hour's work per month! To help, we created a system to maintain prospecti.

In order to get good investment performance for their clients, advisors would have to stop overselling American Funds. They would first have to learn how to pick better mutual funds (an insurmountable task for the average commission-based financial planner), spend $1,000 per year on the software to do it, spend a few hours per month doing the work, then an extra hour or two maintaining the prospecti farm, paperwork, etc.

Why do all of that work when American Funds are "good enough" and clients' are too ignorant to know if they're getting decent returns or not anyway? After all, client's aren't sticking with the advisor because they're getting great performance, they're loyal because the advisor and staff are so friendly, nice, easy to get along with, and trustworthy. Doing the right things would just mean working more and getting paid less. Since few are complaining, this way pays the best, nobody knows to correctly compare performance, clients care more about fancy brochures than results, and the overseers are happy, why would anyone want to do that?

American Funds continue their lock on the Broker Dealers because they and their reps just don't know any better, don't know how to properly compare investment performance, are lazy, it still is the best way to maximize income, habit, it's the path of least resistance that's been working great for over two decades, armies of wholesalers are out schmoozing daily, and regulators haven't gotten around to doing anything about these types of abuses. American Funds makes life wonderful, so why rock the boat?

Let's put a spotlight on the biggest misconception: That American Funds have superior investment performance.

It's All in the Results

Most of American Funds' 22 mutual funds are just average when performance is properly compared with similar mutual funds and proper benchmarks. No matter how you look at it, they don't suck and they're not great. They're just average, mediocre, or in the middle of the pack. About a quarter are good, half are okay, and a quarter are bad.

None of their mutual funds are super-star performers. Even Morningstar's flawed Star Rating system ranks only about 10% of them (two to three) with five stars at any given time. Every once in a while, they get lucky and have great performance in the short run, like a few months in a row here and there. Then they revert back to mediocre. It’s been like this since the '90s.

American Funds have never been good at being pure to asset classes. For example, American Funds calls their #1 fund, American Growth Fund, a U.S. Large-Cap Growth fund. In reality (April '10), it held ~9% in cash, ~1% in bonds, ~17% in foreign investments, ~20% in Value stocks (of all sizes), and ~5% in Mid- and Small-Cap Growth stocks. When you add it up, it holds a minority of the types of securities that its name leads one to believe it holds (growth). This should be over 90%.

This means people trying to use intelligent asset allocation strategies to reduce risk, will have their efforts thwarted by mutual fund managers buying the kinds of stocks they shouldn't be. This increases risk, which results in losing more money than expected when markets go down. More importantly, it means that when Large-Cap Growth stocks go up, this fund will greatly lag the rest of the pack. Lack of asset class purity is never a good thing, which is why it's a major part of our mutual fund screening process.

Our Large-Cap Growth fund picks, both load and no-load, have consistently outperformed by around 20%. So even their star-performer is easy to beat.

Several of their mutual funds have had way way way too much money invested into them for way way way too long. This is because they were recommended over everything else by financial planners for the last 25+ years.

Some say, "American Funds are more conservative." They're mistaking the lack of their funds going up more than markets, and down about the same, as having some superior investment strategy that will result in losing less money in bad markets. As you can see below, this isn't because of some superior conservative strategy. It's from being so bloated that their funds act more like index funds (with loads and high expenses) than regular mutual funds. This may save investors from losing a little here and there in bear markets, but they're going to miss out on several times the profits when during bull markets.

These mutual funds have so much money in them that they have to hold a little of most every stock traded. This is known as being "bloated." The result is investment performance that just matches the markets/asset class.

There are charts of Investment Company of America (ICA, their #2 fund) on this Word document that compares it to the Large-Cap Value Index since the start of the 21st century.

Compare the two colored lines. They're pretty much identical, meaning ICA's performance is the same as the asset class. This means you could have realized the same, or better (depending on the month), investment performance yourself by using the asset classes' index fund, and saved a ton of money in front-end load sales commissions and annual 12b-1 fees.

The second chart shows the results if you would have invested $10,000 into the Vanguard Value Index Fund during the same time frame. The point is that these two investments (ICA and Vanguard Value Index Fund) are essentially the exact same type of investment vehicle - Large-Cap Value mutual funds. This is shown by the green and blue lines being at the same place at the end of the time frame. This is an apples-to-apples comparison, meaning both mutual funds have the same risk and return characteristics.

This illustrates the effects of American Funds being bloated - they have to buy essentially every stock, so it's the same as being an index fund. Why get index fund results when you can probably do better?

A return graph of our current Large-Cap Value mutual fund pick is also shown on the second chart on the Word doc. The difference in performance compared to AF ICA over the same time frame would have been $30,826 vs. $11,716. That's around 163% more money! For investors living off their investment portfolio income, that means around twice more retirement paycheck. Are you awake now? Probably not, American Funds has a way of brainwashing people so well that they rarely wake up.

Their #3 fund, Washington Mutual (and two others), ranked in the fourth quintile compared to its proper benchmark index over the last five years. This means if you put all similar mutual funds (Growth & Income) into five piles ranked by performance; where the first pile had the top 20% of the mutual funds with the best performance (the first quintile), it would have been in the second-to-worst worst performing pile.

In May '10, three American Funds were in the bottom quintile for Last 12 Months returns. Two to three were in the bottom quintile for last three, and ten, year's returns. So on average, 10% to 20% of their funds are consistently ranked as worse as a fund can get compared properly to their peers over the most important time horizons. This is not good.

All of their other enormous mutual funds have the same problems, and a high percentage are in the bottom half when performance is compared correctly to similar mutual funds and their appropriate benchmark index.

Their performance gets worse every year as this bloating is continually compounded with way too much new money. New money coming in has to be invested into something, because they can't hold 25% in cash, or their performance would be even worse. They can't just buy more of the "good stocks" because they would have to file with the SEC if they held more than 5% of a corporation's outstanding stock.

Another problem with bloating, is that their funds have to hold way too much in cash, because they can't find enough stocks to buy. Six of their 22 funds held over 7% in cash as of the last month. You're not paying the fund managers to put your money in the bank, you're paying them to buy and sell stocks. You hold cash in your account so you can use it when needed, so you don't want more than a couple percent held inside your mutual funds. American Funds consistently holds several times too much.

Even if their most bloated mutual funds magically were cut in size by half, they would still be enormously bloated. Growth Fund of America had more than $67 Billion as of the last month. In order to only have "winning stocks" it would have to shrink that down to under $25 Billion. So it's two to three times as big as it should be in order to not be just an expensive index fund.

You also can't be well diversified by owning several different American Funds, because most have to own the same stocks (because of the massive over-bloating). So when you buy AMCAP, Growth Fund of American, or New Economy, you're getting pretty much the same stocks because the same stocks are all in the top ten holdings of all three funds.

The right thing for American Funds to do is to close bloated load funds to new investors. They should have done this around 1995. But this is a mutual fund family that's all about "Show me the money," so they'll never do that. Just the fact that they don't close their bloated mutual funds is proof that they care more about maximizing their income than getting above average investment performance for their shareholders. This is never a good thing.

Their strategy of high-growth of assets under management and collecting even more assets all the time is still going strong. We went to a focus group in 2000 sponsored by people trying to find out how investment advisors select mutual funds. The invitation we received in the mail looked like we were doing the industry some big academic favor to help humanity. After fishing every detail out of us, like all of the things it would take for a fund company to get more of our assets, they gave us $100 and then told us it was conducted by American Funds. Big surprise. And where does all of this money come from to be able to afford to put on shows like this in big cities that pay advisor big money just to get their opinions - you the shareholder pays for all of the via the high 12b-1 fees.

People have been pointing all of this out for years, so these are not new complaints.

Conclusions

The reason few investors know about the mediocre performance, is because nobody has ever listed their problems, and/or compared them properly before, and posted the results in a place that stays put.

This information is in the media all the time, but only for a week and then it's gone. The only place you'll see the performance of a suitable American Funds portfolio properly compared on a monthly basis, is here and here.

If mutual fund families were popular based on consistent long-term superior performance, then T. Rowe Price and Oppenhiemer would be the two most popular mutual fund families. They not only have around twice the number of asset classes, and are much more pure to asset classes, but many of their mutual funds are consistent star performers. This is the only way to consistently beat the market indices.

When a financial planner puts fancy sales brochures in front of people new to investing, this and what the salesperson says, are usually all they have to go by. They don't know how to find important information like this. Even if they did, they probably wouldn't understand it. If they did understand it, and contacted their salesperson, all they'd get is blah blah blah about how American Funds are the best thing since sliced bread. Even if they wanted to get better mutual funds, they don't know how. Then their attention spans are too short to go through all of that research and paperwork.

Once investors place their trust into the advisor's recommendations, the commissions are deducted, the deed is done, and the investor is stuck. In non-qualified accounts, there are taxes to pay if American Funds were sold to buy better mutual funds. Because of ignorance, fear, and short attention spans, the investor is usually stuck with their American Funds for decades.

Everyone that was sold American Funds by a financial salesperson should do their homework with respect to performance. These days, there is no reason why American Funds are superior to their competition. The more you do your homework, the more you'll reach the same conclusion.

Then you should question your financial advisor on why you were sold such mediocre-performing mutual funds, which lack the asset classes needed to lower risk through diversification, and have such high costs of ownership. The truth is, "That's how me and my Broker Dealer make the most money from you! Plus I don't know how to do the research to find better-performing mutual funds, my Broker Dealer wants me to use them, and I'm too lazy to maintain a supply of mutual fund prospecti or learn the paperwork for more than one mutual fund family." It's hard to teach old dogs new tricks, so the self-perpetuating myth about American Funds being superior will be around for a while longer.

You should also look into learning how to invest your money yourself. How to do that is explained in detail here, here, here, here, here, and here. After you get the basics down, you can transfer your American Funds portfolio into a self-directed online discount brokerage account. If you're in a tax-qualified retirement plan (IRA), then you can sell them all and invest the money into better performing investments, and escape all of this forever, without paying any taxes or sales loads.

About opening a discount brokerage account so you can manage your own money is discussed here

We think you'll do way better by just investing in an appropriate portfolio of no-load index mutual funds or index ETFs. And we think you'll do even better than that by using our mutual fund recommendations and/or our asset allocation software to invest your own money.

It's the 21st century - Just say no to American Funds! Why - because at best you're basically paying the maximum sales commission for the privilege of buying a market index fund (with no load and a fraction of the fees). At worst, well....

Face it, if you own American Funds, then you were just bamboozled by an ignorant financial advisor working at the lowest level of enlightenment as possible in the financial industry who's priority is feeding themselves first, making their Broker Dealer happy second, and whatever it is you want (like getting better than just "okay" returns"), well that's last and least in importance. American Funds are just an easy and safe default way to get just okay returns, while maximizing salesperson and Broker Dealer revenue, having to do the least amount of work, grease everyone's skids, and take the least risk, all without having to teach old dogs new tricks they can't learn. So in an industry where the fox has always guarded the henhouse, this is a perfect business model. Which explains the constant cash inflows, which just makes the funds more bloated, making everything worse.

Everyone makes mistakes, and it's easy to do when a polished professional salesperson appears to care and know what they're doing. And look at all of the fancy color brochures with all of the happy satisfied customers! Wow they must really be the best to afford all of that. The other funds suck at that, so who wants them? Who pays for all of that - shareholders (you) in the form of high 12b-1 fees. How can I go wrong with all of that, and my favorite country is even in the company name! I'm a patriot, here's my checkbook please sign me up now! Face it, this was you.

To make you feel better, you were not bamboozled because you were ignorant. You were bamboozled because you thought that some government agency was supervising an industry with the critical function of protecting your only nest egg. I mean, c'mon look at what doctor's and lawyers have to go through to practice, and this is probably even more important in some cases. It's just not logical to let a whole sector of the economy run amok with my life's blood, so there has to be some laws, rules, and regulations, right? I mean, this salesperson is telling the truth and know what they're doing and are not out to screw me just to make a little more quick easy money right? Big Brother can't be everywhere BUT here, right?

This was your mistake, the fox has always guarded the henhouse in this industry (learn more). It's only since their chickens have started to come home to roost in 2009 that the consequences of their collective actions hit the general economy enough to wake people up to the fact that Wall Street has just paid everyone off to the point that they can just run amok to the point of bringing humanity within ten days of ending in Jan '09. Caveat emptor. You need to do your homework when working with a financial professional several times harder than if you had cancer and were shopping for second opinions. You owning American Funds is the end result of trusting the government to look out for you, when they're being paid well not to.

If you're one of these salespeople reading this, then please ask yourself, which part of any of this is not true? It's all true, c'mon you know it. This is just the status of life in this biz today. We're selling stuff too. All you have to do is get with the Model Investor's program and this won't be you anymore.

Our advice for American Funds shareholders is to sell them. Here's generic advice on how for both taxable and nontaxable accounts:

Taxable (non-IRA/401k) Accounts: Because most of them are just bloated index funds, wait until that asset class is down and your shares are lower than your purchase price. Then sell them and buy a better fund in the same asset class the same or next day. If you time it right, you may even be able to include the sales charge as part of the capital loss on your taxes!

So if you're in a non-tax-qualified account (and have to pay tax on profits), then if you sell at a loss, there's no taxes to pay and you get to use this loss to credit/offset gains on your similar investments (this is a good thing and you want this, especially if you can also deduct the sales commissions). Then you just buy a different mutual fund (not ETF) in the same asset class. Both will be down at the same time, so you're not losing anything on the sell other than the insignificant ticket charges and your time. If you bought a different asset class, then it may be up, which would be bad so don't do that. In this case, you want to dump something that's down and buy essentially the same thing when it's down too. This also makes it so no market timing is needed - all that's needed is for the AF shares to currently be trading less than your bought them for. The only reason market timing would be needed is if you had to pay taxes on profits. Then you'd need to buy something that's down more than what you're selling to make up for the expense of taxes.

Tax laws are complex here, so if you're in a non-qualified account, then you need to learn all about that too. Even if it is a "wash" from an initial trading and tax point of view, we feel the mutual fund you just bought will de better than the American Fund (and we don't even know what it will be!). Why? The #1 reason is that American Fund NEVER pass out monthly mutual fund screening process. If they did, then this page would not be here. What this means in English, is that chances are you'll do some homework on your own for a change, and buy a better fund as a result of that. Many funds pop up in our screens, so chances are you'll be led to them via the actual evidence. There's an ample supply that pass our screens, and American Funds never do, so the probabilities of doing better just from this are in your favor. The mutual fund recommendations page has more on this (and you can get our current mutual fund picks once for a whole $9, so this will tell you what to buy, so no homework is even needed).

Non-Taxable Accounts: Just sell out all of American Funds the next business day and replace them with different mutual funds in the exact same asset class. This way your portfolio allocation will be the same, just the funding vehicles will be different. Since there's no taxable events, the only loss are the ticket charges and your time. Both are insignificant compared to being able to escape American Funds - and hopefully the advisor that bamboozled you too, which in the long run could be much more significant to your life than just having your portfolio worth a few percent more over time by eradicating American Funds. The effects financial advisors working at this level can do to you with similar future self-serving blunders could literally precipitate the end of you and your family.

Other links on the subject:

Lawsuit about American Fund's business practices

Diehard.org's opinion

A Business Week magazine article

A Money/CNN article

About the Attorney General of California suing American Funds   More