The era of online brokerages taking advantage of clients holding mutual funds is finally coming to a close.
Do-it-yourself investors holding mutual funds? Aren’t online brokerages a refuge for people fleeing expensive do-nothing mutual funds? For sure, they are. Yet billions of dollars in online brokerage assets still sit in mutual funds, some of it very well invested indeed. In fact, there are solid reasons for DIY investors to consider mutual funds and we’ll look at them in a minute.
First, a bit of history. For decades, online brokers have been paid by mutual fund companies for providing both advice and service to clients who hold funds. Online brokers are prohibited from providing advice (they’re strictly order-takers), so these trailing commissions were not earned. Securities regulators recognized this disconnect in a recently announced decision aimed at stopping payment of trailing commissions to online brokerages starting June 1, 2022.
Where possible, online brokers typically route clients buying mutual funds into a D-series product, where trailers have largely been removed. But it may still be possible to buy Series A and B funds with trailers, and there may be long-time investors who bought these fund series many years ago and continue to hold them.
Collecting trailing commissions is a black mark on the online brokerage business, although it has to be said that individual investors bear some responsibility, too. Trailing commissions are detailed in various disclosure documents in a way that should ping the radar of any fee-conscious investor.
The publicity over trailing commissions and online brokers has undermined the idea of DIY investors using mutual funds and so has the rise of much cheaper exchange-traded funds. But there are still three good reasons for DIY investors to consider mutual funds for their online brokerage account:
1. Great for PAC plans
You can set up monthly preauthorized contributions to a mutual fund without having to pay any brokerage commissions; the commission to buy an ETF typically comes in between $5 and $10.
2. Dividend reinvestment couldn’t be simpler
When buying a mutual fund, you can choose a dividend reinvestment option that automatically uses your dividends to buy more fund units; this means dividends don’t pile up as cash in your account while earning zero interest.
3. Access to smart, reasonably priced money managers who can do the work of investing for you
D-series funds are considerably more expensive than ETFs, but you may be surprised at how much less pricey they are than traditional mutual funds. Also, funds from low-cost fund companies such as Beutel Goodman, Leith Wheeler, Mawer and Steadyhand may be available (check your broker). Some of the balanced funds from these companies are worth a look for investors seeking a simple way to build a diversified portfolio.
Finally, a warning about DIY investing in mutual funds. Find out if you have Series A or B mutual funds in your online brokerage account and switch to Series D where possible. More on this in a column I wrote (tgam.ca/Carrick-feetrap) a while back.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.
Rob Carrick