American Funds is a household name. It is part of Capital Group and is one of the largest investment managers in the United States with almost two trillion dollars under management. I originally researched American Funds because I have an account locked up with American Funds as part of a 401(k) plan. So, is American Funds a rip-off? Or is that expensive American Funds investment worth it? That is the question that I hope to tackle today.
Hopefully this post will help better inform small businesses and individuals who are sold American Funds products so they can make an informed decision.
What does American Funds Do Well?
Before I lob some well-deserved criticism in the direction of the Capital Group, I do think that we should appreciate what American Funds does well: behavioral psychology with an aim to stay invested long term. This may be a byproduct of trying to keep customers from switching to cheaper competitors, but, when so much of investor success is based on staying the course, American Funds should be applauded regardless of motivation. American Funds can help people overcome their behavior biases, whether it be complacency through automatic investing or negative behavioral biases like overconfidence or fear of losing in the short term by controlling what information is presented with a focus on years and not days, weeks, or months.
Viewing that an investment has moved up or down by several percent in one week is only going to encourage poor behavior (like selling when the market is low). When your horizon is long term, you have no business tracking daily price fluctuations.
Are American Funds products actually a rip-off?
The short answer is it depends, but, for many people, yes. Specifically, it depends on which share class you invest in. American Funds does an odd behavior in which they offer almost a dozen share classes and not all share classes are offered to all people. Unfortunately, some share classes can be many times more expensive than others because of embedded salesperson commissions. If you buy an expensive fund or a fund with a sales load (an upfront percentage sales charge), then yes, American Funds is a total rip-off. However, if you can find a decent “F” share class fund or large company retirement product with lower fees, then American Funds is actually quite competitive and offers good products (if you like actively managed funds).
Ethically, I believe that selling loaded funds or funds with excessive expenses is a questionable behavior and one that, while lawful, should make investors beware. Unfortunately, American funds only sells the worst funds to small 401(k) or other retirement plans and also directly to investors through its network of investment salespeople. I call them salespeople because they are not fiduciaries, meaning that they will recommend a fund to you because the fund pays the salesperson a hefty commission even if it is not the best share class for the investor. It is hard to trust a company which will take advantage of your lack of knowledge or that allows its sales force to give advice that is not in the investor’s best interest.
To better explain the difference in fees, the following table compares different share classes of the same Growth Fund of America Fund and accompanying 1, 5 and 10 year returns. Remember, all of the differences in return for the American Funds product stems from the differences in fees. I will also compare it to one of its main competitors, the Vanguard Growth Fund Admiral Shares.
|Fund and Share Class||Where is it sold?||Expense Ratio||1 Year Returns||5 Year Returns||10 Year Returns|
Growth Fund of America A (AGTHX)
American Funds salespeople
0.62 plus 5.75% load
Growth Fund of America R-2 (RGABX)
Small 401(k) plans
Growth Fund of America F-1 (GFAFX)
|3rd Party Brokerages||0.69||6.69||11.37||13.39|
Growth Fund of America R-6 (RGAGX)
|Giant 401(k) plans||0.33||7.00||11.78||–|
|S&P 500 Index||–||–||7.35||11.34||13.24|
Vanguard Large Cap Growth (VIGAX)
Vanguard, some 401(k) plans
All data is monthly pretax returns as of 10/31/2018, and any sales loads are included. You cannot invest directly in the S&P 500 because it is an index and therefore it has no expense ratio. The R-6 Share class above had no available data for 10 year returns.
As you can see, funds sold in the F-1 and R-6 share classes actually did very well. Over certain time periods, they actually beat the Vanguard fund VIGAX, an impressive feat. This outperformance is seen in other time periods. However, the much more expensive A and even the R-2 share classes fall far behind because of the drag created by fees. It is unlikely that these funds will ever catch up to the competing Vanguard growth fund.
High fees benefit only the fund manager and the fund salespersonEveryone Ever
I do not like that American Funds charges high fees at the expense of its less savvy customers or to retirement plans which limit choice to expensive funds only. These high fees benefit only American Funds and the fund salesperson. This makes me question whether or not even the savvy investor who buys an F share class on a third party platform should be willing to trust American Funds with their money.
That said, fees really define the quality of a product because it directly affects the end returns the investor receives. Savvier investors who use brokerage platforms to buy F shares and giant 401(k) plans actually get a decent deal from American Funds because the fees are much more reasonable. However, many will never experience the lower fee version of American Funds, and for these people the company falls dismally short. In my opinion, American Funds is a rip-off for anyone who spends more in fees to gets less return.
American Funds Utilizes 3rd Party Advisors Who Are Not Knowledgeable
Another issue I have seen is when 3rd party American Funds “advisors” tell people to do crazy things. For example, I saw an American Funds asset allocation recommended by an “advisor” to a 25 year old telling her to purchase 50% an emerging market fund and 50% a United States large cap balanced fund but nothing else, and both of these were purchased as A shares. No advisor should ever recommend putting 50% into an emerging market fund and, even worse, no advisor should tell a person to purchase A shares with a sales load. Yes, I understand that American Funds does not actually hire these advisors. However, I believe that American Funds should vet them for at least basic knowledge of how to build a portfolio. The truth is, these advisors only sell American Funds products because of the juicy commissions and they know very little about investing.
American Funds misleads investors by using bad benchmarks
This is nothing unique to American Funds. Many companies do this. It is common place to compare a fund to the S&P 500 index even when the S&P 500 is not a good fit for what the fund is trying to accomplish. For reference, the S&P 500 is an index of the largest 500 publicly traded companies in the United States in proportion to their value on the stock market.
This is a problem because funds that attempt to track only certain types of stocks should be benchmarked against indexes that match the investment objective. By doing this, an investor can know at a glance how the fund is actually doing in the greater world of investments and against the true benchmark. Two examples of this are The Growth Fund of America and the Fundamental Investors funds, both of which are erroneously benchmarked to the S&P 500. The Growth Fund of America is a growth fund meaning that it should be benchmarked to something like the S&P 500 Growth Index. Also, Fundamental Investors should be indexed to something like the Morningstar Large Blend Category (a quasi-index) because it invests in foreign and other holdings.
Without meaningful benchmarks, the chance of misleading a customer is much higher. From my anecdotal experience, this leads to people investing in products they should not merely because for the last year or two it beat the S&P 500 index, albeit with potentially higher risk and lower diversification. Also, by using the wrong benchmark, American Funds is able to hide underperformance and exaggerate outperformance on some of their funds.
While I understand that using bad benchmarks is industry standard, I believe that American Funds should follow Charles Schwab’s example and include in a best fit index or at least a Morningstar Category average.
Conclusion: American Funds Puts Itself Before Its Clients
I don’t think American Funds is an awful company for all investors. However, I do think that American Funds is a typical example of a profit-maximizing corporation that does not care much about its customers unless they have a very large account. As demonstrated above, you can find funds from American Funds which perform well when the price is right. However, American Funds does not have any qualms with charging different customers vastly different prices for the same product and that concerns me. For me, I am going to stick to low cost index funds and fund managers who take a fair approach on fees.
So how could American Funds fix these problems? First, they should eliminate A shares with sales loads and simplify share classes so that everyone gets a good deal, even if large accounts still pay less per dollar invested. American Funds should better vet it’s network of salespeople for basic knowledge and also should benchmark their funds to more meaningful metrics.
Author: Kelton Johnson
Disclosure: I am long the Growth Fund of America and Fundamental Investors in unfortunately expensive share classes. This post was not sponsored by Vanguard or Schwab. The link to Schwab is a referral link, but I receive no commission if you use it. The link will, however, provide you with a $100 bonus for opening an account.