The Problem with Mutual Funds

The Problem with Mutual Funds

A friend recently told me that when he’s been searching around for financial advice online, it seemed that it was almost a universal perspective that letting one of Canada’s Big 5 banks – RBC, TD, BMO, Scotiabank, and CIBC – sell you a mutual fund is a very, very poor choice. He wondered why that was. It was especially troubling for him because his retirement savings were accumulating in a mutual fund at one of these Big 5 banks. The answer to his question is illustrated in the following series of images.


 

The Problem with Mutual Funds

The problem with a lot of the “actively managed” mutual funds that the Big 5 offers is onerous fees. High fees, over time, eat away at the total value of your portfolio. It’s just the nature of how compounding works.

I’ve selected one mutual fund from each Big 5 bank that I believe would be the fund pushed on for the majority of people seeking mutual funds: the balanced growth funds. These mutual funds can come with an array of fees: from back load and front load fees to MERs. I will strictly focus on MERs here. The graphs I will use below only represent the effects of MERs on the total value of a portfolio.

1. CIBC

Let’s start with CIBC. They charge the highest MER of the five funds I am sampling, with their CIBC Balanced Fund Series A at 2.45% MER. Let’s take a look at the erosion of your total assets over time in this fund:

CIBC Balanced Fund Class A

2. TD Canada Trust

TD charges the second most with their TD Balanced Growth Series A Fund. At 2.30% MER, these are the results:

TD Balanced Growth Series A

3. Scotiabank

Scotiabank’s aptly named Income Growth Advantage Fund isn’t giving you much of an income advantage the longer you hold the fund at 2.09% MER:

Scotia Income Advantage

4. RBC

RBC’s Select Growth Series A Fund isn’t much better:

RBC Select Growth

5. BMO

BMO had the lowest MER of the five funds at 1.75% with their Asset Allocation Fund:

BMO Asset Allocation Fund

What About ING?

ING is marketed as an alternative to the Big 5. They offer convenient services and low-to-zero account fees. The mutual funds they offer are better than the Big 5. Here is a graph and spreadsheet image of ING’s Streetwise Mutual Funds:

ING Streetwise

What’s the Big Deal?

Is there a pattern you’ve noticed with all of these mutual funds? The longer you hold them, the more money you lose to the bank. It’s quite astonishing to think that one or two percent per year could erode your total assets with that kind of ferocity. It’s scary stuff and you should be aware of this tyranny of fees. I’d rather not lose 71.07% of my total assets after 50 years to CIBC. Would you?

Where Do I Go from Here?

The uncomplicated easy answer? Index mutual funds. Specifically, the TD E-Series Index Funds. It’s fairly straight forward to set up through TD Canada Trust or TD Waterhouse. It will take some of your time, but the benefits of substantially lower MER fees will be worth the time you spend to get it set up tenfold. Creating your own balanced growth fund will only cost you 0.42% MER. Here is what the effects of that look like:

TD E-Series

Losing 19% of your total assets to the bank after 50 years is a hell of a lot better than losing 71%. You must always keep in mind that there are and will always be fees when it comes to investing. You can’t control that. Fees are a universal truth in the world of finance. What you can control is how much you pay in fees.

A little research and a little math can go a long ways towards keeping more money in your pocket rather than the bank’s.

  • Interesting article. I don’t know Canadian investing laws well; it is much of a hassle to regularly invest in lower cost mutual fund providers outside of Canada such as Vanguard or Fidelity?

    • It’s a bit harder in Canada. TD offers an index mutual fund for low MERs and ETFs are the best bet for lowest MERs, but those aren’t cost efficient until your asset base is over $25k.

      I wish we could buy Vanguard like Americans can!

      • We can buy Vanguard like Americans can. Of course, you have to hold the funds in US dollars opening up some currency risk and conversion costs but it’s definitely possible. I currently hold some VTI in my Questrade RRSP.

      • Sorry I should have been more specific: yes we can buy Vanguard, it’s just that we’d have to buy it in American dollars like Stephen stated!

        I guess for the average investor, even the step of having American funds to purchasing and American index fund might sound too risky and too complicated.

  • Good advice! Mutual funds are a nonsense, particularly as it seems that over time fund manager’s stock picks are no better than a child throwing darts at the stock pages. I posted an example from the work of Daniel Kahnemann here: http://wp.me/p359Na-G.

    “A Random Walk Down Wall Street” and “The Wall Street Defense Manual” opened my eyes to this. I guess you know them?

    Glad to have wandered into your blog (I came via Sarah Hahn’s blog: http://wp.me/3mwvu)

    Cheers

    Chris

    • Haha I would agree that most of the time fund managers are throwing darts blind – you’d be astonished by the turnover in funds year after year!

      Thanks for the Kahneman read! I got first introduced to Kahneman through Nassim Taleb in his book “The Black Swan”. Great book – albeit a little abrasive – if you’re looking for a read in the area of finance.

      Sarah has a great blog!

      • Nassim Kaleb – looks interesting, and, bonus, it’s in the local library! Oh goody.

  • Bookmarking this for later review. I like the charts. I have a small mutual fund with ING/Tangerine I started 3 years ago before I knew much about investing. The bulk of my savings is in common stocks & ETFs instead of the MF. It’s performed well so I’ve never looked at it in detail but it’s probably time to analyze it properly.

    • With the market having been on a fantastic bull run since 2009, if think your Tangerine mutual fund would have done fairly well even with the ~1% MER.

      Conceivably, you could just cash it out now and hold the cash to buy your eft when the market dips – but that is market timing and I don’t know if I condone doing that 😀

  • Thank you for this very useful post. However, if you want to diversify your investment choose mutual funds with different fund type. What other people don’t like much the mutual funds its because of sales load and management fees and exit fee as well.