There was a time that mutual funds were one of the best ways for the average person to invest in the stock market, but those days are now long gone.
Now it’s easier than ever to get lower-fee products with better investment returns. Unless you’ve found the unicorn mutual fund that’s outperforming the rest of the stock market, chances are staying invested in your bank’s mutual fund is to your detriment.
It’s entirely up to you if you want to retire hundreds of thousands of dollars poorer, but if you’re thinking you’d like to keep that money in your pocket, read on. It’s time to ditch the mutual fund.
Mutual fund definition
A mutual fund is a financial investment that you typically buy through your bank or another financial institution. It consists of a collection of securities that are selected and managed by a financial professional. A mutual uses a pool of money from investors to invest to buy stocks and bonds.
Typically you put any amount into a mutual fund, because unlike individual stocks are ETFs, you can purchase fractional shares (usually called units). When you purchase mutual fund units, it can take 3-5 days for the trade to “settle”, so the number of units may differ slightly from the amount you were quoted at time of purchase.
Mutual funds often will pay distributions to shareholders on a quarterly, bi-annual, or annual basis, similar to dividends from a stock. You can choose to have these distributions paid out to a savings or chequing account, or reinvest them in the fund.
Mutual funds aren’t bad investments, they’re just not the best
Mutual funds aren’t inherently bad, but they’re not as good as they could be. And they’re nowhere near as good as other financial products available on the market.
That isn’t to say mutual funds provide no benefits. Because mutual funds are typically index funds that invest your money in a broad and diverse number of different stocks, they provide you exposure to the stock market at a much lower cost than if you were to buy individual stocks yourself.
Furthermore, because the mutual fund is managed by a portfolio manager and a team of analysts, you have professionals making the investment decisions for you so you don’t have to do the research and make all the trading decisions yourself.
Truthfully, it’s better for someone to be investing in mutual funds than not investing at all. Mutual funds are still a much better choice than leaving your money in a savings or chequing account. But they are not the best investment product out there!
So then what’s wrong with mutual funds?
The above might seem like mutual funds are a good thing, but they have major downsides. Mutual funds cling to the very things that all financial data says leads to underperformance: active management and high fees.
Mutual funds are actively managed investments, which means the portfolio management team is making decisions about what to buy and sell all the time. Every time you make a trade, you pay trading commissions, and these eat into your portfolio returns.
Additionally, no one can time the market, not even someone with a finance degree who’s been investing for decades. Study after study shows that trying to pick and choose the time to invest always lags behind just letting your investments do their thing.
Finally, mutual funds charge really high fees for all the active trading they’re doing! The same active trading that is already costing you returns is going to cost you even more in management fees and other administrative costs. These fees are charged to your portfolio even in years the investments underperform on the stock market return is negative!
Mutual fund fees will ruin your retirement
Mutual funds typically charge anywhere from 1% to 3% in management fees. This is part of the Management Expense Ratio (MER) that gets charged to you for the costs associated with managing your investments.
You might think 1% or even 3% doesn’t sound like much, but over the course of your investing lifetime, it can cost you hundreds of thousands of dollars.
For example, let’s say you open a TFSA this year and deposit $6,000. You contribute $6,000 every year for the next 35 years, and earn an average rate of return of 10%.
|Robo Advisor||Mutual Fund|
|Rate of return||10%||10%|
|Time invested||35 years||35 years|
|Value at retirement||$1,731,655.77||$951,540.25|
|Amount spent on fees||$225,719.68||$1,005,835.20|
If you did this with a robo-advisor charging you a 0.50% management fee, your portfolio will have grown to $1,731,656. If you put your money in a mutual fund charging a 3% management fee, your portfolio is only worth $951,540. It’s a staggering 63% difference totalling over $780,000.
It is literally the difference between you retiring a millionaire or not!
Robo advisors and ETFs killed mutual funds
If you’re wondering where to invest instead of mutual funds, the answer is to use a robo-advisor or manage your own portfolio of ETFs.
Both robo-advisors and ETFs give you the same benefits of index investing as a mutual fund but at much lower costs. You’ll pay about 0.40% to 0.70% in fees for a robo-advisor and as low as 0.08% to 0.50% MERs with ETFs! The result is more money stays in your account to grow and you end up with more in retirement.
Mutual funds vs Robo Advisor
Robo advisors are the ideal solution for people who don’t want to manage their own investments. You simply deposit your money in your account, and they’ll take care of the rest investing in the stock market for you.
Much like mutual funds, robo-advisors do all the legwork of investing on your behalf. You don’t have to lift a finger! Except they do it for a management fee of around 0.50% plus any ETF MERs within the fund. The total cost still comes well below 1%, making robo-advisors incredible value compared to mutual funds.
Robo advisors are so popular now many of the big banks are offering them. My favorite by far is Wealthsimple, who will give you $50 for opening an account with at least $500, but there’s plenty more out there. Check out our comparison of The Best Robo Advisors in Canada to see!
For more info, check out our Wealthsimple Review here!
Mutual funds vs ETFs
ETFs are also a grab-and-go option, but you have to choose the ETFs yourself, which will take some time and a solid understanding of how to build a balanced investment portfolio. If you want to learn how to take charge of your investment portfolio, check out The Six-Figure Stock Portfolio.
MERs on ETFs range from 0.08% to about 0.5% but some go as high as 0.8%. Nevertheless, their management costs are a fraction of that of mutual funds.
At the end of the day, any kind of investing is better than not investing at all. But if you’re going to work for your money, you better make sure it’s working for you! There is no such thing as fee-free investing, but even cutting your costs by 1% will reap six-figure rewards over your investment lifetime.
My investment journey began with mutual funds. If I had not invested in mutual funds, I would not have dipped my toes in the world of investing and I likely wouldn’t have been able to buy a house.
The one other reason that you did not discuss in the article behind why mutual funds charge high fees is advice. In my experience, I never got investment advice from the supposed “Investment Advisor” who sold me the mutual funds, which were always “Series A” that are notorious for the highest MER and have front-loaded fees. So the advisors typically made 1% off my invested money even before I left their office. How crazy is that? Obviously, they never told me that.
I sold all my mutual funds to buy my house and since then moved to ultra-low-cost ETFs. I now pay an average of 0.06% and I used to pay a cringe-worthy 3%!
You know, I was OK with Mutual Funds while I was contributing through my employer a few percentage points a month (or whatever) and while the nest egg was only a few hundred grand and growing slowly. Keeping track of all those small amounts is what, to me Mutual Funds were invented for.
But, once you have (lets say) $MILLIONS in your fund, it is totally dumb to let “them” take 3% (also, lets say…) of the total, annually. That is my biggest issue. If you have $1M in the fund, 2% of that is $20,000!! taken every year.
At some point, it should make sense to pay an advisor to manage your money. For small amounts, Mutual Funds are fine, but once it is big enough, they should charge less (but they don’t), or you should switch to something smarter.
Pretty sure Warren Buffet does not pay into Mutual Funds!
No, mutual funds are NOT all “actively managed” and do NOT charge 1%+ fees. This article is at best uninformed, at worst actively deceptive. Most of the big mutual fund companies offer very low cost index funds that track the market and will generally beat any active investments over the long haul.
Mutual funds are managed by the fund manager, David.