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Traders work on the trading floor at the New York Stock Exchange in New York City on April 5.Andrew Kelly/Reuters

Don’t forget to wish your mutual fund a happy birthday. While you’re at it, ask it to remind you how much you’re paying to hold a 100-year-old instrument that has been surpassed by better, cheaper alternatives.

It’s officially been a century since the advent of the mutual fund, which remains the investment of choice for millions of Canadians saving for retirement.

That loyalty comes with a steep cost. The premium fees that traditional mutual funds carry are silent portfolio-killers, devouring returns on a scale that Canadians still don’t seem to appreciate.

Even the average everyday investor will pay hundreds of thousands of dollars in fees over their lifetimes if they rely on mutual funds. The baffling part is that they do so voluntarily.

In some ways, we can think of investing as a solved problem. For most savers, the optimal approach is to get broad market exposure in a boring, diversified portfolio at the lowest possible cost. This is the where the exchange-traded fund truly shines.

Thanks to ETFs, we are in a golden age of DIY investing. These days, you can get a globally diversified split of stocks and bonds in a single ETF charging fees as low as 0.2 per cent – about one-10th the cost of a traditional mutual fund.

A few clicks of a mouse on a discount brokerage website, and bam, you’ve got an all-in-one balanced portfolio.

This is a fine example of why ETFs are often said to have “democratized” investing for the masses. But to be fair, the same was said of mutual funds decades prior.

In March, 1924, the first U.S. mutual fund – the Massachusetts Investors Trust – was launched. Unlike the shady pooled investments of the day, this fund could issue additional shares if there was demand and would ensure that investors could sell their shares at a fair price.

This would become the prototype for an industry that now manages more than US$60-trillion globally.

The mutual fund was an ingenious invention that gave even modest investors a piece of the capitalist economy.

But eventually, the industry came up with a better mousetrap. American investors understand that. ETFs are quickly gaining ground and now control about 30 per cent of all U.S. fund assets.

The transition in the United States is happening even faster than that by some measures. ETF launches have outpaced mutual fund launches for four straight years, according to Morningstar data. And the passive investing style that is at the heart of the ETF movement now controls more assets than active funds in the U.S.

For some reason, Canadians aren’t as sold. There is more than $2-trillion residing in Canadian mutual funds, compared with about $400-billion in ETFs. Product launches are heavily skewed to new mutual funds. And active funds still dominate, with an 84-per-cent share.

Why are we so beholden to a product that has not rewarded our loyalty? It’s well documented that the vast majority of mutual funds fail to generate the kind of consistently superior performance that would justify their fees.

Canada’s banking oligopoly explains a lot. Many Canadians get financial advice through their banks, where advisers are heavily incentivized to peddle the bank’s own lineup of mutual funds. These sales are far more lucrative to the banks than ETFs. In fact, most banks do not even allow their branch-based advisers to sell ETFs to clients.

It’s also rather obvious that many Canadian investors still don’t have a clue how much they’re paying in fees.

That’s not entirely the fault of investors. For decades, those fees were largely hidden from them. And recent efforts by regulators to improve fee disclosure still exclude some of the costs of mutual fund ownership.

A few years ago, the Mutual Fund Dealers Association published a report showing that fewer than one in five Canadian investors could correctly identify what exactly they’re paying in their fee summaries.

Safe to say that confusion also applies to what exactly constitutes a high fee. A management expense ratio of 2 per cent doesn’t sound exorbitant. But that must be weighed against one’s expected return. If that’s 6 per cent, that means fees are chewing up one-third of your gains.

Compounded over many years, the cumulative effect of mutual fund fees can be staggering.

Let’s say you sock away $5,000 each year in a portfolio fund like RBC Select Balanced Portfolio, which is the largest mutual fund in the country, with more than $50-billion in investor money. Assume it gains an average of 6 per cent a year. The fund has an MER of 1.94 per cent, meaning that after 40 years of saving, you would have paid about $320,000 in fees. Nearly 40 per cent of your invested wealth would be swallowed up by fees.

Let’s not forget what the mutual fund has done for us over the last century. But every investor needs to consider whether it’s time to move on to the next one.

Editor’s note: This story has been updated to remove a comparison of the RBC Select Balanced Portfolio mutual fund to a low-cost index fund to illustrate the effects of mutual fund fees. The comparison was based on performance figures that already accounted for fees paid by investors.

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