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Mutual funds vs. ETFs: Know the nuances in the fees you pay

The ETF crowd will love this reality check on one of the country's favourite mutual funds.

The $14.7-billion RBC Canadian Dividend Fund is a fair bit costlier to own than its seven direct exchange-traded-fund competitors, and its returns lag behind most of them in recent years. Mutual funds versus ETFs: It's the greatest rivalry in investing and it's also the most misunderstood.

By all means compare the costs of owning both, but don't make the mistake of ignoring the value you get for the fees you pay. ETFs may well come out on top after this more nuanced comparison, but not always.

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RBC Canadian Dividend Fund is a giant in the popular Canadian dividend and equity income category. The average management expense ratio (MER) for the six largest funds in the group is 1.9 per cent, which compares with 1.78 per cent for RBC Canadian Dividend. By mutual fund standards, it's a reasonably priced choice for people seeking an easy way to hold blue chips listed on the Toronto Stock Exchange.

Now, let's deconstruct the cost of owning RBC Canadian Dividend. A full percentage point of the fee is accounted for by trailing commissions, which are used to pay people who sell funds and their firms for the advice they provide (note: disclosure documents for RBC Canadian Dividend say it can charge a trailing commission as high as 1.15 per cent).

If you get investment and financial planning advice from the person who sold you RBC Canadian Dividend, then you have reason to be a satisfied investor. But if you bought the fund from a branch staffer who mainly acted as a sales person, then the trailing commissions embedded in this fund's fees are buying you advice you're not actually receiving (read my column last week on fund fees and RBC Canadian Dividend: tgam.ca/DqST).

Securities regulators are currently considering the idea of separating the cost of owning a fund from advice-related fees, that is, trailing commissions. Until that happens, an investor who was sold RBC Canadian Dividend without any advice has a few options: Suck it up and stay in the fund, try a lower-cost D-series version of the fund we'll look at in a moment, or migrate to an ETF.

Before we consider fees, let's be clear that RBC Canadian Dividend and its ETF competitors are quite similar investing products in that they hold lots of familiar blue-chip stocks. More than 70 per cent of RBC Canadian Dividend's assets are invested in stocks in the financial and energy sectors. The iShares Dow Jones Canada Select Dividend Index Fund (XDV), one of the biggest TSX-listed dividend ETFs, has 67 per cent of its assets invested in those sectors. The Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY), the lowest cost dividend ETF in this comparison, is 87 per cent invested in financials and energy.

Fees are a much bigger differentiator between RBC Canadian Dividend and its ETF competitors. With an ETF, there's a comparatively small MER that doesn't typically include advice. If you want advice, expect to pay 1 to 1.5 per cent of your assets each year in addition to the cost of owning ETFs.

The transparency of owning ETFs is much better than mutual funds, whether or not you have an adviser. But will your returns also be better? Let's see.

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One of the drawbacks with dividend ETFs is that most have been around less than five years and thus don't have returns that can be compared on a long-term basis with veteran products like RBC Canadian Dividend. Since its inception date in January, 1993, the fund has made an average annual return of 10.9 per cent. Who wouldn't be satisfied with that?

There are two dividend ETFs that have been around for five years and they both outperformed RBC Canadian Dividend. The three ETFs with a three-year history all outperformed RBC Canadian Dividend, which has done comparatively well lately.

For do-it-yourself investors or people who own RBC Canadian Dividend without getting any advice, it's fair to compare the fund directly to ETFs on fees. But if you have a useful adviser, then you need to recognize that the fees you're paying cover financial planning services as well as the cost of your investments.

For the well-advised investor, the correct way to compare RBC Canadian Dividend and similar funds to ETFs is to add advice costs to the MER for the latter. We've already seen that the trailing commission for RBC Canadian Dividend is 1 per cent. Now, let's say you buy an ETF through an adviser who charges an advice fee of 1 per cent of your account value. If you add that 1 per cent to the fees charged by our seven dividend ETFs, you get all-in costs of 1.35 per cent to 1.99 per cent.

There is no standardization of charges among advisers who offer fee-based accounts to clients, so we ought to look at how ETFs compare when you pay higher advice fees. If you paid 1.5 per cent instead of 1 per cent, the all-in cost of using the seven dividend ETFs would erode their performance advantage significantly, but not entirely.

Trading costs also have to be considered in a comparison like this. As a no-load fund, it costs zero to buy or sell RBC Canadian Dividend. Two online brokers, Questrade and Virtual Brokers, offer free purchases of ETFs – you pay to sell – while Scotia iTrade and Qtrade Investor both include a Canadian dividend choice on their limited menus of commission free-ETFs. Otherwise, the cost of trading ETFs ranges from $10 to $29, depending on how big your account is.

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It's the actually the D-series of RBC Canadian Dividend that compares best with ETFs, not the more widely held A version. RBC's D-series of funds are aimed at DIY investors who are customers of online brokerage RBC Direct Investing and want mutual funds. The fees for these funds are reduced to reflect that they're purchased by DIY investors who get no advice – RBC Canadian Dividend D has an MER of 1.21 per cent, for example.

Even the D series of this fund lags ETFs over the longer term, though. The mutual fund haters in the ETF crowd will love that.

For more personal finance coverage, follow Rob Carrick on Twitter (@rcarrick) and Facebook (robcarrickfinance).

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998. Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More

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