How Index Funds Compare To Equity Mutual Funds

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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  1. Derek on September 22, 2019 at 7:19 am

    Are the rates of return before or after the fees?

    • Robb Engen on September 22, 2019 at 7:55 am

      Hi Derek, the posted returns are always net of fees.

      It’s interesting to see that the difference in returns between the equity funds and the index funds is almost equal to the difference in their fees.

  2. Ian on September 27, 2019 at 10:06 pm

    BMO has a lovely set of series D ETF wrapper funds. Here’s one side-by-side with VGRO and XGRO:

    Yet, if you look around BMO’s website, they don’t advertise it at all! A google search will bring up some fund facts PDFs, but god knows how you’re supposed to even find them!

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