How to Build Your Own Mutual Fund

Fajasy
Updated: September 3, 2020

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Disclaimer

In this article, I will discuss the two investment platforms you can use to build your own mutual fund in 2020. This is only possible with the power of fractional share investing, automated rebalancing features, and a more involved active management role.

Although creating your own mutual fund is entirely possible, for most investors I would recommend sticking with a low expense ratio ETF such as the VOO. This ETF tracks the S&P 500 Index, which is extremely hard to beat, even for seasoned investors. Moreover, the expense ratio of only 0.03% is far below those of mutual funds which average between 0.5% and 1.0% annually.

Regardless, below are several reasons on why you may want to create your own mutual fund:

  • You do not want any fees or expenses whatsoever.
  • You cannot find an ETF that aligns with your investment principles (i.e. a socially-conscious S&P 500 following ETF).
  • The ETF you want to invest in has too high of an expense ratio, has companies you dislike, or has too high or low of a weight in certain industries or companies.
  • You also want to invest in bonds but want to avoid fees and/or expenses associated with fixed-income and balanced funds.
  • You want to have control of your investments and change them overtime as you age and your goals change.

If you fall into one of these criteria, I'd recommend reading ahead. If not, stick to low-expense ratio ETFs that have done well with tracking their underlying index and invest in other asset classes separately.

How to Build Your Own Mutual Fund With M1 Finance

The first method I will cover, and the one I recommend for most investors looking to start their own mutual fund, is to utilize an investment brokerage called M1 Finance.

M1 Logo RGB
M1 Finance Logo

There are no hidden charges if you choose to invest on M1 Finance, and it's completely free to use.

Here are the three main features M1 Finance offers that gives investors the ability to create a mutual fund:

  • Fractional share investing: If you want to put $25 into Microsoft (MSFT), which trades at around $220 per share, you can do this through fractional share investing on M1 Finance.
  • Automated rebalancing: M1 Finance balances your portfolio for you and keeps your investments at your target allocations.
  • Automated dividend reinvestment: Once your cash balance exceeds $25, M1 Finance will automatically reinvest this amount across your portfolio based on your target allocations, which is great for dividend investors and long-term growth.

Hopefully, you can see why M1 Finance is a great option for creating your own mutual fund. In particular, the automated investments and re-balancing, along with fractional share investing makes building your own mutual fund possible.

With most other investment brokerages, although you could purchase stocks and bonds to make a mutual fund, these holdings would become out-of-balance overtime. This is simply because various investments in your portfolio will grow to have a larger weight than others, which may alter the performance you're expecting.

For example, let's say you purchased Apple (AAPL) and Disney (DIS), and wanted 50% weights in both investments. A month passes by and Apple happened to outperform Disney since, causing the weight to now shift to 51% Apple and 49% Disney. With most investment brokerages, you'd likely have to balance this back to 50-50 manually.

However, M1 Finance would do one of two things, assuming a 50-50 weight in Apple and Disney:

  1. It could sell your Apple shares and invest that into Disney, utilizing fractional share investing if necessary. Although this works, you will be taxed (unless in a non-taxable account) on any gains and your long-term growth or any dividends will be cut or lowered as well.
  2. It will use any additional money you put into the account and allocate these funds to underweight holdings to eventually re-balance the portfolio back to 50-50. This is the better of the two options.

So, now that you know why M1 Finance is a great platform for creating your own mutual fund, the next step is to decide your allocations to create your pie, as M1 Finance likes to call it.

The major downside to M1 Finance currently is that you can only own up to 100 different securities, any more is not allowed. So, although you cannot replicate an S&P 500 Index ETF with your pie, you can still invest in one like the VOO, as mentioned before, which only has a 0.03% expense ratio.

The method I would recommend is to find a good performing ETF or mutual fund with not as much holdings, and to then download a spreadsheet file of all the holdings in this ETF and their respective weights. Then, you could spend some time and delete any companies you don't like, or simply use the same ones and allocations the ETF already includes.

FinBox (need to register a free account) is one way you can do this. You can view different investment portfolios, and copy the same investments as Ray Dalio and Warren Buffet, for example. You can also filter what type of investor you want to mimic, and can filter out certain industries as well. So, if you wanted to replicate a ETF in the financial services industry, you could filter out all other industries.

Finally, you should reallocate, re-balance, and change allocations as you get older, that way you have the proper allocation up until your retirement date. For example, you'd likely start off with a more aggressive portfolio when you're younger, but a more conservative or moderate portfolio as you get closer to retirement.

Lack of Tax-Loss Harvesting

One thing that M1 Finance does not offer is "tax-loss harvesting," also called "tax-loss selling." This is when investments with an unrealized loss are sold, and then similar ones are bought back to recognize an artificial loss. There are tax laws that state you can reduce taxable income by as much as $3000 per year by recognizing these capital losses.

An example of this is if you were invested in Home Depot (HD), but were at an unrealized loss of $1000. A robo-advisor investment platform may sell Home Depot at a loss and replace it with Lowe's (LOW), a company in the same industry and with a very similar business model, which may perform similarly as well.

So, these investment brokerages may recognize this artificial loss and this can be used to reduce your taxable income. Tax-loss harvesting is also great for re-balancing your target allocations in your portfolio as well.

Unfortunately, this is a feature that is not currently offered with free investment platforms like M1 Finance. However, tax-loss harvesting has its drawbacks as well, such as impacting future returns, so it's not too much to be upset over.

Finally, although M1 Finance does offer something called "Tax Minimization," it does not appear to be as effective as tax-loss harvesting.

How to Build Your Own Mutual Fund With Folio (Motif) Investing

Folio Investing, by FOLIOfn Investments, Inc., was launched in 2000 to offer investors the option to achieve low-cost diversification through combining investments in mutual funds, ETFs, and individual stocks. Motif Investors were forced to switch to this platform after Motif Investing, a very similar platform with a lack in profits closed on May 20th.

FolioInvesting
Folio Investing Logo

This platform is based on "folios," which are essentially just securities customized to meet a specific investment need. You can create as many folios as you want, and each folio contains up to 100 individual securities, which gives it a slight edge over M1 Finance.

If you have the Folio Unlimited Plan for $29 per month of $290 per year, you essentially have commission-free trades. However, if you have the Basic Plan you have to pay a $4 commission per window trade per security. Furthermore, although there are no investment or balance minimums, you have to pay a small fee on any market, limit, stop, and stop-limit orders, regardless of your selected plan, and $15 per quarter if you make under 3 trades with their Basic Plan. M1 Finance therefore is the much better option in this regard as they offer unlimited commission-free trades and it does not cost anything to open an account.

Again, much like M1 Finance you can allocate your investments equally across all of your holdings using market cap weightings or decide on your own security weightings. You can also use fractional investing with as little as $25, which is what M1 Finance offers as well.

One notable feature Folio Investing provides is its "Tax Football" investment tax tool, which identifies securities you can sell to achieve a specific tax result. In other words, Folio Investing provides tax-loss harvesting that will allow you to generate potential gains to offset any losses you may have made. In my opinion, this is the main advantage Folio Investing has over M1 Finance.

Besides this, creating a mutual fund on Folio Investing is similar to the process M1 Finance investors follow. So, it really comes down to costs, preference, and your investment strategy when deciding between the two, which the next section will compare.

M1 Finance vs. Folio Investing

The table below provides a comparison of the two investment platforms, geared towards the features that are most important if you are to create your own mutual fund.

FeatureM1 FinanceFolio Investing
Commissions$0$4*
Account Fees$0$5-29/mo.**
Order Fees$0$3-10/mo.**
Fractional Shares ($25)YesYes
Auto Re-balancingYesYes
Dividend ReinvestmentYesYes
Order ControlNoYes
Overall Interface & Usability4.5/53/5
Account Types3.5/54.5/5
Tax Optimization3/54.5/5
Securities in Portfolio100Unlimited
Margin Rates3.50%****5.75%

*Folio Investing has a $4 trade commission for its Basic Plan, and 2,000 commission-free trades in twice daily trading windows ($0.50 for each additional security trade in a window during that month).
**Folio Investing has a $15/quarter. fee for the Basic Plan if the account has less than 3 trades per quarter, and $29/mo. or $290/year fee for their Unlimited Plan.
***Folio Investing has $3 order fees on their Unlimited Plan and $10 order fees on their Basic Plan (for market, limit, stop, and stop-limit orders).
***M1 Plus $125/year premium membership can bring this down to 2.00%, and includes a second trading window.

In short, I would only recommend Folio Investing if you're looking to own lots of different securities (over 100), and if you believe the fees are worthwhile. It's also the better platform if you need access to additional account types and order control, alongside tax-loss harvesting. Otherwise, I would strongly recommend that investors use M1 Finance to build their mutual fund.

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