Improved financial literacy is waking people up to the fact that mutual funds are a comparatively expensive way to invest.
But anti-mutual fund sentiment is starting to go too far. On my Twitter feed last week, someone asked me why I am not "screaming from the rooftops" that mutual funds are a "sucker bet." Many funds are just that. I can't argue. But there are too many good fund products out there to make such generalizations accurate. You can be sensible, successful investor using mutual funds, just as you can be with exchange-traded funds and individual stocks.
The problem the mutual fund industry has with fees is that it doesn't explain itself very well. So let me try. With the typical equity mutual fund, 1 percentage point of the fee is directed by your fund company to the advisory firm that sold you the fund. With bond funds, it's 0.5 of a point. If we assume a portfolio 75 per cent weighted to stocks, 0.75 of the fees charged to own funds would be for advice.
To properly compare mutual funds to lower-cost ETFs, we need to add the cost of advice to the analysis. My Freedom 0.12 portfolio of ETFs gives you a fully diversified package with an aggregate management expense ratio of 0.12 per cent. An adviser might conceivably manage the Freedom 0.12 portfolio for you, but there would be a cost of 1 to 1.5 per cent for his or her total package of services. This brings the cost of having ETFs and an adviser to 1.12 to 1.62 per cent.
Data from the Investment Funds Institute of Canada shows that the average asset-weighted MER for mutual funds with embedded advisory fees in 2015 was 2.06 per cent. If we use this number to compare to the Freedom 0.12 ETF portfolio being run by an adviser, we see the cost premium for mutual funds has diminished considerably. The differential would run between 0.94 percentage points to just 0.44.
Mutual funds are a flat-out more expensive way to invest, even if you adjust for the built-in cost of advice. In exchange, you get the ability to buy and sell and switch between funds at no cost in most cases, you get no-cost dividend reinvestment and you get access to portfolio managers who can offer a smart complement to the indexing approach commonly used by ETFs.
ETFs beat mutual funds on fees, but the difference may not be as shocking as you think.