Chances are you have already invested in a mutual fund or two, and while there are some benefits you are likely taking advantage of, they can be VERY expensive and can easily erode your investment returns.
In this blog post, I will show you how you could potentially save thousands per year by switching to an ETF strategy.
Thank You, Oh Mutual Fund
Before I completely tear mutual funds apart, I’d like to give them a little praise because they do serve a purpose:
They are convenient and easy to get started with. Pretty much anyone with a chequing account can go into the bank they hold it with and open up a mutual fund account.
Other benefits mutual funds offer are instant diversification (sometimes) and regular, simpler contributions. You can set-up automatic purchases to invest a little bit each month, lending you to take advantage of dollar-cost-averaging and consistent portfolio increases.
Now, ETFs can offer most of these benefits as well but at a HUGE discount…
Sorry, My Dear Mutual Fund
The biggest downside with mutual funds is their often massive MERs.
An MER is the fee that the fund “charges” behind the scenes in order to pay the fund’s business costs and sales commissions. This fee can range anywhere from 0.6% all the way up to 3%!
That might not seem like a big deal. I mean, even at 2% you are only paying $2 out of every hundred, but when you put that in proportion to someone who has accumulated a $500,000 (or more) nest egg, that’s $10,000 a year!
Regardless of which way the market moves…
Now, I’d like to walk you through an example to illustrate just how much these fees can add up to.
Let’s say you have $100,000 invested in a broad market mutual fund consisting of approximately 60% equities and 40% bonds (like TDB887 for example), from which you might expect to earn an average annual return of about 8%. Let’s also assume you are holding your investment for 20 years.
How much money would you have?
After 20 years of patience, with your investment compounding at 8% your $100,000 would be worth $466,095.71. Great work!
Now, what would you actually have after you take into account the drag from your massive MER? Your 8% return shrinks into a 6% return, and after compounding for 20 years you’re left with…
That’s a difference of $145,382.16, more than your original investment!
Couple that with the fact that the MER skims 2% off your portfolio value no matter if the market goes up or down and you could end up with even less.
So, what can you do about it?
Luckily, the financial products industry has blessed us with a type of fund, similar to mutual funds in ways, that offers instant, broad diversification, good returns, and very low fees.
Enter the E-T-F.
ETFs, like mutual funds, invest in a whole basket of equities or bonds offering reduced risk through diversified holdings. However, unlike mutual funds, an ETF portfolio will rarely have an MER more than .5%, and many are as low as .2%.
I’m sure you can imagine this could have a profound effect on your investments, but let’s revisit the example from earlier to drive the point home.
If you had been invested in an ETF with the same asset mix (like XBAL.TO for example), over the same investment horizon, you could expect a similar pre-MER return. Just this time your real return after fees would be much closer to 7.8%.
And what would that give you for a final portfolio value?
Or, $128,419.71 more than if you have stuck with your mutual fund.
That’s a fair chunk of change that I’d rather keep in my account.
Why isn’t everyone doing this?
Well, for starters, many people don’t know that this is even an option – hence why I started this blog.
Second, it just isn’t for some people. It is more work and people can easily get confused or scared because it is their life savings they are working with and they find comfort in having their bank’s advisor tell them they got it handled.
Again, this blog will hopefully help alleviate the concerns and barriers so that anyone who wants to save on fees feels confident doing so.
And third, there are many people who believe that investing needs to be complicated and you can’t just buy an index and hold it for 20 years and expect to get decent returns.
Some people even think their mutual fund is better than the rest and they will outperform any passive strategy and therefore can outweigh the extra fees.
I suggest these people review the SPIVA reports here showing that almost 99% of actively managed equity mutual funds underperform the S+P/TSX Composite Index.
So how do you do it?
There are a few steps involved to get started with ETF investing, with one of the main ones being having the right account to do so. ETFs trade just like stocks on an exchange (ETF stands for Exchange Traded Fund) so you would be wise to sign up for a discount brokerage account.
I wouldn’t recommend getting your bank’s financial advisor to start buying ETFs for you as there are likely hefty commissions to broker the trades. Questrade offers commission free ETF purchases further reducing costs, and if you need help getting an account opened with them I outline how to do so in this blog post.
You will also need to choose some ETFs or an all-in-one option, a topic I intend to cover in detail in a future post.
And then you need to place the actual trades, which I will be making a how-to guide on how to do just that in the future.
Or you can skip all that and go straight to a robo-advisor, who will set you up with an ETF portfolio suited to your investment goals, then buy and balance your portfolio automatically, all while offering the ease and convenience of mutual funds.
They do of course charge a fee for doing so but the MER and robo-advisor fee put together still doesn’t even break .5% (for Questwealth at least).
As you can see, a high MER can have a detrimental effect on your lifetime portfolio gains. By switching to an ETF strategy you can save thousands each year and retire with a lot more money than if you held your expensive mutual fund for your entire investment horizon.
If you have any questions about ETF investing, I’d love to hear them. Just ask in the comments below and I will do my best to answer them. And if you know anyone who is interested in mutual funds, send this post their way with hopes that their portfolio can one day reach it’s full potential!