Mutual funds have been getting a bad rap lately with their high fees, low disclosure and under-performance.  The introduction of ETFs has given investors a lower cost alternative.

Even David Chilton did an about face in his new book The Wealthy Barber Returns recommending ETFs instead of mutual funds.

It is true that the mutual fund industry is losing market share to ETFs but they still have $871.1 billion in assets under management (according to Investment Funds Institute of Canada – IFIC), and net sales of $5.41 billion so they are obviously part of many portfolios.

Who would benefit the most from holding mutual funds?

New investors and small investors

For someone just starting to invest and only able to contribute small amounts each month, mutual funds are a good choice.  You can start an automatic purchase plan for as little as $25 per deposit.

Related: How To Start Investing Your Money

New investors are often quite conservative and afraid of losing their money.

With this fear of risk it’s easy to be talked into buying mutual funds; holding money market instruments, fixed income and even the popular balanced funds.

However, with today’s low interest rates, the fees will quickly eat into your returns so you’ll have little or no earnings.  If you are this conservative it’s better to stick with a high interest savings account.

Otherwise, take the plunge and buy a low cost Canadian index fund.  Take a look at the top 10 holdings and you’ll probably recognize the companies you’re about to have ownership in.

  • TD Canadian index fund – e-Series MER 0.33%
  • RBC Canadian Index fund – MER 0.72%

You can then branch out into a US Index fund, International Index fund and Bond Index fund to round things out.

Mutual funds are an ideal way to start building up a portfolio.

Convenience 

All financial institutions offer mutual funds.  What could be easier than walking into your branch and opening up an account immediately?

Contrary to popular opinion, bank advisors must successfully complete a securities related course before they are permitted to sell mutual funds, and often take regular in-house training courses.

Related: Why A Fiduciary Standard For Investment Advisors Is Needed In Canada 

Yes, they will emphasize the positive benefits of their own funds but you don’t expect the sales staff at The Source to recommend a better deal for you at Best Buy.  You need to do your own due diligence just as you would with any major consumer purchase.

One Globe 5-Star rated bank mutual fund is:

  • BMO North American Dividend fund – 1-year return is 14.83%, and the return since inception is 6.52% per year.

Many people don’t want to set up a brokerage account.  They may be too intimidated or just plain not interested in do-it-yourself investing with a discount brokerage, or not have the required minimum account size to use a full service brokerage or fee-based financial planner.

Mutual funds invest in a professionally managed pool of securities that provide instant diversification.

Check your banks website for fund information, or go to Globe Investor or Morningstar to compare bank and mutual fund company funds and rankings.

What about those fees?

Canadian mutual funds have the highest MERs in the world.

ETFs are more cost effective so you retain more of your earnings.

Of course, both of these statements are correct.  Years ago mutual funds had strong returns so fees were not often an issue, but now, with lower expected returns, the fees are harder to justify.

Low cost investments look more attractive however, consider other variables besides MERs.

  • ETFs are subject to a brokerage fee – up to $29 per trade.  To be cost-effective you need a few thousand dollars for each transaction rather than small monthly purchases. (Note: Questrade recently announced that its clients can now buy any ETF in North America commission free)
  • Registered plans (e.g. RRSP, RESP) held in a brokerage account charge an annual fee of up to $100 for accounts under their minimum required balances (often $50,000 to $100,000).
  • Why are some people are happy with a cheap haircut from Magic Cuts while others will pay over $100 at a fancy salon.  Some people will pay higher fees for the pleasure of dealing with their favourite advisor rather than doing their business by phone or online.
  • Foreign and sector funds have higher MERs, but will give portfolio diversification not easily or inexpensively available in individual stock purchases.  For example: Eleanor has a core portfolio of bonds and dividend stocks and receives about $50 a month in investment earnings.  She decides to set up a monthly purchase plan into an emerging markets mutual fund.  She realizes the MER is higher for this fund and recognizes it’s volatility but is willing to take the risk for this small amount.
  • The majority of investors need advice and it’s necessary to pay a fair compensation to advisers and money managers for their services.  For the mutual fund investor it is paid by management fees.

The Bottom Line

The bottom line is that you’ll pay some kind of fee for everything but fees should not be the sole, or even major, determining factor when making a purchase.

There are hundreds of investment choices to make and obviously not all are suitable for everyone or for every situation.

Related: Investors Getting Short Changed From Banks, Advisors

It’s important to strike the right balance to achieve your goals with the right products at the right time.  Mutual funds may be just the ticket.


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