Weekend Reading: Investor Bias Edition

Home country bias is when investors overweight domestic stocks relative to their weight in the global market. Canadian investors tend to suffer from home bias, but this is also true of investors in most countries. It’s particularly troubling in Canada where our stock market is highly concentrated in the financial and energy sectors.

A related investor bias that I’m seeing more and more is something I’d call “industry bias”. This is where technology workers tilt more of their portfolio to tech stocks, and oil and gas workers invest more in energy stocks, etc.

There’s also regional investor bias. If you live in oil country you’re more likely to invest in those companies, and if you live in Silicon Valley you’re more likely to invest in technology firms.

I’d consider these more dangerous than home country bias because it further concentrates your portfolio in one particular sector of the market and misses out on key diversification benefits. An even more extreme example is when an investor’s entire portfolio is made up of his or her own employer’s stock – whether through an employee stock purchase plan or stock options.

I understand the idea of investing in what you know. But picking individual stocks in one particular industry just because you live or work there doesn’t make any sense. Any insider knowledge or advantage you think you have is already priced into the market.

Furthermore, tying your retirement portfolio to your own employer’s stock is equally unwise. Employees who find themselves in this position would be smart to move away from such a concentrated portfolio and adopt a core-and-explore approach with 90 percent of their assets in a low cost, globally diversified portfolio of index funds or ETFs, and leave 10 percent or less to their employer stock or industry sector.

This Week’s Recap:

Earlier this week I wrote about how index funds compare to equity mutual funds. All the banks offer index funds that cost less and have performed better than their expensive equity mutual fund counterparts. So why don’t you ever hear about them?

Over on the Young & Thrifty blog I reviewed the robo-advisor WealthBar.

A reminder, on September 26th I’ll be hosting an AMA (ask me anything) on Reddit Personal Finance Canada.

Many thanks to those of you who signed up for the $199 financial planning service. This ‘light-advice’ service is designed for those who can benefit from someone taking an objective look at their finances, highlighting any ‘gaps’ or potential areas for improvement, and getting some actionable takeaways to implement on their own.

If you’d like me to look at your finances and address your ‘money gaps’ just complete this questionnaire, identify your one financial area of importance, and I’ll follow up to analyze and address the ‘gap’.

Promo of the Week:

The Canadian Financial Summit goes live this week, with sessions beginning on September 26th. There’s such a great variety of topics and speakers this year. You’ll hear sessions on asset allocation ETFs, robo-advisors, solving the RESP puzzle, renovating your house on a budget, insurance in retirement, and so much more.

My session on retirement readiness will go live on September 27th. You’ll want to catch the entire conference live with this free ticket.

Can’t catch everything live? Not to worry. Get instant lifetime access with an All Access Pass for just $87.

Weekend Reading:

Stephen Weyman at Credit Card Genius shares the best credit cards for shopping at Costco.

I took my family of four to Europe on Aeroplan miles and only paid a few hundred dollars in taxes and fees. That’s because I flew on United Airlines instead of Air Canada, and United doesn’t impose fuel surcharges. Here’s a comprehensive guide to Aeroplan’s fuel surcharges to help you avoid the fees.

Bryan Borzykowski helps us understand the chatter around negative interest rates in his latest MoneySense column.

Here’s why don’t-pay-till-you-die reverse mortgages are booming in Canada.

Andrew Hallam explains why your returns might be better with all-in-one ETFs than with individual funds.

Morningstar’s latest research on mutual funds is out and Canadians get a below average grade on fee experience.

Not every risk in the market is about to pop. Why we love to call everything a bubble:

“I have often thought that we are all products of when we ‘grew up’ in the market. So, for example, folks who grew up in the ’70s are always looking for inflation. Those who grew up in the ’80s are always on alert for a crash.”

Josh Brown and Nick Maggiulli, of Ritholtz Wealth Management, discuss data on investing a lump sum vs dollar-cost averaging, and the results might surprise you:

Jason Heath says the real ‘advice gap’ when it comes to financial planning has nothing to do with investment products.

Michael Batnick offers a behavioural prescription for dealing with volatile markets:

“There have been 17 separate 5% pullbacks since stocks bottomed in 2009. Each one of them felt like the top.”

The Blunt Bean Counter shares an entertaining post about investing like your grandmother or grandfather.

Here’s Jason Heath again answering a reader question: Will selling my house help me retire sooner and more securely?

Tim Cestnick says the lessons learned from this TFSA story gone wrong could save you a huge headache.

Finally, a huge congratulations to Million Dollar Journey blogger Frugal Trader, who recently reached a cross-over point with more than $53,000 in dividend income.

Have a great weekend, everyone!

How Index Funds Compare To Equity Mutual Funds

This article was originally published more than seven years ago and remains of the most widely read investing pieces on Boomer & Echo. I’ve updated the 10-year returns of the funds listed below. Not surprisingly, the returns of low cost index funds still beat the more expensive equity funds.

Despite numerous studies showing that Canadian mutual fund fees are among the highest in the world, and that actively managed mutual funds tend to perform worse than low cost index funds, many Canadians continue to invest their money in expensive funds. Morningstar’s latest research says Canadian investors grade below average when it comes to fee experience, paying an average of 2.28 percent for an equity mutual fund, 2.04 percent for a balanced mutual fund, and 1.49 percent for a fixed-income fund.

Index Funds vs. Equity Mutual Funds

As mentioned above, the equity mutual funds offered by the big banks have management expense ratios (MERs) averaging 2.28 percent (some lower, some much higher). They are sold to investors as a way to beat the market by using a professional management team to actively manage the portfolio – trying to pick what they consider to be the best performing stocks at the most opportune time.

Conversely, index funds are designed to track a specific index and deliver market returns, minus fees, which are typically around 1 percent or (much) less.

I looked at the mutual funds that are offered at each of the five big banks and compared the 10-year performance of high cost Canadian equity mutual funds to their equivalent low-cost index funds.

Here are the results from August 2009 – August 2019:

Fund MER 10-year Annual return
TD Canadian Index Fund e-Series 0.33% 7.01%
TD Canadian Equity Fund 2.17% 5.96%
RBC Canadian Index Fund 0.66% 6.50%
RBC Canadian Equity 1.89% 5.40%
Scotia Canadian Index 1.01% 6.28%
Scotia Canadian Growth 2.09% 4.91%
BMO Canadian Equity ETF 0.94% 5.94%
BMO Canadian Equity Fund 2.39% 5.88%
CIBC Canadian Index 1.14% 6.20%
CIBC Canadian Equity 2.18% 5.20%

The banking industry has led Canadian investors to believe that paying higher investment fees will result in superior returns for their portfolios. Yet in each of the five examples shown above, returns from the high MER equity mutual funds lagged behind returns from the cheaper index funds, often by a wide margin. The lowest cost fund, TD’s Canadian Index e-Series fund, also happened to be the best performer over the past decade.

Related: TD e-Series funds are not just for beginners

For decades, low cost index funds, and more recently low cost index ETFs have provided higher returns when adjusted for investment risk. According to the 2019 SPIVA Canada Scorecard report, which tracks the performance of actively managed Canadian mutual funds versus that of their benchmarks, more than 75 percent of Canadian equity fund managers trailed the S&P/TSX composite index benchmark in 2018. The results get worse over time for active managers. More than nine in every 10 funds under-performed their respective benchmark over the 10-year period.

Unfortunately, index funds are not marketed very well by the financial industry, as advisors have little incentive to sell them to you.

The major reason why actively managed mutual funds in Canada lag behind their respective benchmark is fees. A deeper look at their make-up explains why. Canadian equity mutual funds are, for the most part, closet index funds. They hold the exact same stocks that make up the S&P/TSX composite index. So no wonder they can’t beat their benchmark index. They charge active management fees for a portfolio of index-hugging stocks. Not a great recipe for success.

Final thoughts

Mutual funds are still a great place for investors to start building their portfolios, but Canadian investors need to do a better job understanding the high MERs they are paying, and start demanding lower cost funds from their advisors.

You don’t have to settle for the expensive equity mutual funds recommended by your bank financial advisor. Ask questions, shop around for cheaper index funds, or look into ETFs as a low-cost investment alternative. Don’t let your portfolio get eaten up by unnecessary fees.

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