Mutual fund investors caught by deferred sales charges (DSCs) understand their downside.  They’d like to sell their funds but face penalties as high as 7% if they sell.  DSCs are set to be banned across Canada (but only restricted in Ontario) in mid-2022.  Until then, mutual fund salespeople masquerading as financial advisors can still sell funds with DSCs to unsuspecting investors. Before DSCs existed, it was common for advisors who sold mutual funds to get a “front-end load,” which is a fancy term for giving some of an investor’s money to the advisor or the advisor’s employer.  So, an investor might invest $50,000 with an advisor, but the first account statement might show only $47,500.  The missing $2500 was a 5% front-end load offered as an incentive to the advisor to hunt for mutual fund buyers. Not surprisingly, investors didn’t like to see a big chunk of their savings disappear like this.  Mutual funds had a problem.  They needed to give commiss...

The high cost of having a financial advisor has been in the news lately. A recent example is Jonathan Chevreau’s discussion of the problems with Deferred Sales Charges (DSCs) and the future of financial advice . The banning of DSCs everywhere in Canada except Ontario is reshaping how financial advisors get paid. However, this discussion only covers a fraction of the costs mutual fund investors pay every year. Mutual fund companies silently dip into Canadians’ mutual fund savings every year for a percentage called the Management Expense Ratio (MER). Too often, this is 2% or more. This may not sound like much, but when you lose 2% of everything you have saved every year, it adds up quickly. Over 25 years, about 40% of your money is gone. Out of this MER, mutual fund companies pay financial advisors roughly 1% to choose their funds for investors. The remaining money from the MER goes to the fund company. But what do they do for their money? Most of the largest mutual funds ...

Every year market research firm DALBAR reports how investors’ mutual fund returns compare to market benchmarks. The results get reported widely and are always dismal. In one example, Seeking Alpha says “Investors Suck at Investing” (see the comments for a link). A few people have criticized DALBAR’s methodology, which isn’t surprising given the large number of people who see their reports. What I did find surprising is that this criticism isn’t just nitpicking; DALBAR’s calculations significantly overstate investor underperformance. According to DALBAR’s 2016 Quantitative Analysis of Investor Behavior, In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%. So, for the 20 years from the start of 1996 to the end of 2015, equity mutual fund investors’ actual returns were supposedly 3.52% per year lower than the stock market average. Over the full 20 years, this works...

The Canadian Securities Administrators (CSA) has issued a proposal to ban mutual fund embedded commissions. This would force financial advisors to charge their clients directly instead of getting commissions from the mutual funds that hold their clients’ investments. Whether this makes sense depends on how we view the mutual fund industry. There are two extreme narratives that characterize the fund industry in Canada. Which one you think is closer to the mark will likely decide whether you support CSA’s proposed changes. Narrative 1 : Financial advisors are hard-working professionals who must be paid for the initial work they do for their clients and must be paid a lesser amount each year for their ongoing work helping their clients. Paying the advisors out of client assets within mutual funds is just a convenient way to complete the transaction with a minimum of hassle for clients. Narrative 2 : Mutual funds that pay trailing commissions know that investors are clueless ab...

Creators of mutual funds and exchange-traded funds (ETFs) are always looking for new fund ideas that will attract investors. I have an idea for climate change funds. Suppose that two funds were to hold assets likely to be affected by climate change, such as ocean-front properties. The “scientists’ fund” would short such properties on the theory that they will go down in value as ocean levels rise. The “deniers’ fund” would buy such real estate on the theory that it will be fine and is likely underpriced on fears of rising oceans. No doubt there are many other types of financial assets whose value would be affected by climate change. So, instead of sitting in a bar and arguing about whether climate change is real, people would be able to get some real skin in the game by risking their own money.

A very clever argument used by those who want to maintain the current embedded commission model for financial advisors goes as follows: When you buy a car, you don’t demand to know the size of the salesperson’s commission. So, why would you demand to know the commission your financial advisor gets? Most other arguments the mutual fund industry uses are easily refuted (see Tom Bradley’s excellent article on this subject ). However, this car analogy rings true at first. I don’t worry about how much commission the car salesperson gets. It’s the total price of the car that matters to me. The problem here is that the analogy isn’t an exact fit. For example, almost everyone is aware that car salesperson commissions come out of the car price. Many investors don’t know how their financial advisor gets paid. But the differences run deeper. Let’s imagine a fictitious world where car ownership more closely matches mutual fund ownership. Suppose that instead of paying car salespeopl...

In a recent post , an anonymous commenter took me to task for my opinion that mutual funds should not be permitted to pay financial advisors. Rather than just rebut the commenter’s argument, I want to use it to illustrate an important difference between good and bad financial advisors. Here is the criticism edited for length (the original comment is here ): You say “If advisors are performing a valuable service, their clients should be willing to pay them directly.” How do you reconcile this statement with you making money via advertising on your site? If you feel that should be the ONLY model, why not charge people directly for this site? When you go to a store and a salesperson helps you pick out a product, do you pay them separately or assume their compensation is included in the sticker price? Of course, the reason I don’t try to collect a few pennies each time a reader visits my site is that the overhead would be far too high. It’s obvious which parts of my site are content...

In a follow-up to It’s Not Rocket Science , Tom Bradley at Steadyhand has another investment book out called It’s Still Not Rocket Science . Like the first book, this one is a collection of a few years of Bradley’s essays explaining investment topics clearly. Bradley’s style contrasts sharply with the usual message from the investment industry that investing is very difficult and that you’d better hand over your money before it blows up. Disclaimer: I did not receive any compensation from Steadyhand to write this review other than a free copy of the book. My relationship with them is limited to having met a few times and liking how they treat their clients. I’m a DIY indexer myself, but for those seeking advice, Steadyhand offers lower fees than most other options. Further, Steadyhand is actually trying to beat the index rather than charging high fees for just hugging the index. Here are a few ideas from the book that jumped out at me. Measuring Personal Returns Most do-i...

I wish I had read John Bogle’s book Common Sense on Mutual Funds when the first edition came out in 1999. I might have saved myself a lot of the time and money I wasted trying to beat the stock market. Instead I’ve read Bogle’s updated 10th anniversary edition long after I accepted the wisdom of trying to capture market returns at the lowest cost possible. If any readers are finding their commitment to indexing being poisoned by thoughts of purportedly market-beating strategies, this book is a great antidote. Bogle amasses overwhelming evidence of the mutual fund industry’s failure to help investors capture anything close to the full returns of the market. He lays out so much statistical evidence to back up his case that the reader could benefit from notes at the bottom of pages such as “if you’re already convinced of the current point, skip ahead 10 pages.” The book isn’t just a litany of complaints, though. Bogle lays out his ideas of how a fund company should be run. Thes...

Getting into the Grinchy side of the Christmas spirit, I thought I’d take a look at how both income taxes and mutual fund fees affect TFSA savings. The effects of these costs will vary considerably from one person to another, so we’ll just look at one particular case. From stage left, our saver Sally enters. She saves $5000 in her TFSA every year (rising with inflation) starting from age 25 until she retires at age 65. We’ll assume that she makes a return of 4% above inflation each year (before fees). From age 65 to 85, she draws $15,000 per year to live on (in today’s dollars). For Sally’s tax bite, we’ll look at how much income she had to earn to make the $5000 TFSA contribution. Let’s assume that Sally lives in Ontario and earns between $87,907 and $136,270 so that her marginal tax rate is 43.41%. This means she has to earn $8835 to get $5000 after income taxes. This makes the tax bite on her TFSA contribution $3835 per year. For the bite of mutual fund fees, let’s assu...

In my never-ending quest to clearly explain the devastating effect of investment fees on your savings, I’ve found another way to look at it. Instead of looking at how much of your money gets consumed by mutual fund fees, let’s look at how they affect your retirement age. Suppose that Katie is 30 years old and is just starting out saving in her RRSP. She has set up automatic contributions of $1000 per month. She plans to increase this amount each year to keep pace with inflation. Katie wants to know, “if I plan to draw $3000 per month (in today’s dollars) in retirement until I’m 95, when can I retire?” The answer depends on how her RRSP investments perform. For illustration purposes, let’s assume that her investments beat inflation by 4% per year, before investing fees . Of course, she can’t count on this, and returns vary considerably from one year to the next. But the goal here is to see how fees affect retirement, so we’ll do calculations based on a steady 4% real return. ...

Most people have heard of the Rule of 72 . It’s a way to estimate how long it takes for your money to double at a given rate of return. Less well known is that this rule can be used to estimate how long it will take for investment fees to consume half your portfolio. The Rule of 72 says that if your rate of return times the number of years you earn that return is 72, you’ll roughly double your money. So, if you earn 6% each year, it takes about 72/6=12 years to double your money. When it comes to fees, the same rule works for finding the number of years it takes for fees to consume half of your money. For example, if you invest in Investors Canadian Growth Fund, the total fund costs each year are 3.02% of invested assets. So, it would take about 72/3.02=23.8 years for half your money to be consumed in costs. This rule just gives an estimate, but it’s pretty close. The actual time is just under 23 years. Update 2018 Nov. 27:  This fund's total expenses are now 2.72% per...

BlackRock Canada has launched seven new mutual funds that are built with the iShares ETFs. The main difference between these funds and the typical mutual funds that Canadians own is that BlackRock’s funds are based on passive index investing instead of active stock-picking and the new funds have somewhat lower fees. However, the new funds are still much more costly than building a do-it-yourself portfolio directly using low-cost index ETFs. The new funds consist of six funds covering a range of risk levels along with a seventh fund focused on monthly income. The following table shows the target allocation and costs of the various new funds (management fees plus administration fees for the Series A funds). I compiled this information from the simplified prospectus. Fund Name Fixed Income Canadian Equities U.S. Equities Foreign Equities Fees BlackRock All Bond Portfolio 100% 0 0 0 1.15% BlackRock Defensive Portfolio 75% 15% 5% 5% ...

The explosion in exchange-traded funds (ETFs) in Canada continues with the launch of five new funds in September by Purpose Investments . I had the pleasure of talking to Som Seif (CEO) and Ross Neilson (Vice President, Sales) over dinner recently to get their take on where Purpose fits in the investing landscape. ( Disclosure: Som paid for my dinner, but if you think that affects what I write, you should see how many times per week I turn down offers of far more than the cost of a dinner to place “guest” posts on my blog that masquerade as real content.) Som Seif is a very smart, high-energy guy who started Claymore back in 2005 and now runs Purpose Investments. Ross Neilson is no slouch himself, but even he tends to sit back and watch Seif go. Som shows passion and communicates clearly in a way that I think is likely to resonate with a significant fraction of investors who hear him speak. I don’t know how his funds will perform, but I wouldn’t bet against Purpose Investments ...

A long-time reader who prefers to remain anonymous asked an interesting question about a strategy to pick winning actively-managed mutual funds. Here is an edited version of his question: I'd love to hear your input on a friendly discussion with a good friend on active mutual funds versus passive indexing. I fall on the indexing side of the debate but I'm having trouble finding flaws with the approach he's been using. He looks for 5-star active funds with "low-risk, high-return" characteristics as dictated by Morningstar and/or Scotia Research, then selects funds that have performed better than the group average over short and medium term (1 month to 3 years) under the same management. He will then hold these funds and review every 3-6 months or so, selling them if they no longer exceed the group average returns. Whenever I pick a suitable index (regardless of asset class, though he favors Canadian and Global Small Cap), his funds have almost always done co...

Skiing can be fun, but heading downhill is no fun for investors. So, why do so many of them do it anyway? The following chart shows how performance chasing can turn into investor skiing. Most investments are volatile, which means they go up and down. Whenever an investment like a mutual fund is at its peak, it has a great recent track record and is considered “hot”. The blue fund above jumped from $25 to $39 in only 3 months. It doesn’t get much hotter than this. Our skier poured $39,000 into 1000 units of the hot blue fund, but the party was over by then. He rode it down to $23.50 by April. But, fear not! A new hero has emerged. The red fund doubled in only 3 months. The skier switched to the hot red fund at exactly the wrong time and rode that down to $12. A final switch to the high-flying green fund in July gave disastrous result, too. By October, our skier had only $3000 left. So much for hot funds. This is an extreme example, but it illustrates what happens ...

This is a funny one I got from Ken Kivenko who is a tireless advocate for the small investor up against the giant mutual fund industry. You can read his monthly newsletters at Canadian Fund Watch . Ken says he received the following message signed as the branch manager of a member firm of the Mutual Fund Dealers Association: “Mr. Kivenko, please stop sending your Newsletter to my clients Mr. ----- and Ms. -----. Since they have been receiving your rag they constantly pester us about fund fees, returns and how our Seniors Specialists are paid. The more they read the more anxious they become. They are elderly and your stories are scaring them. It is now virtually impossible to even approach them about our new line of proprietary funds because of your rantings. The next thing I know they'll be asking about alternative investment choices. Our sales team is worried this will spread. STOP sending this material NOW! Have a good day.” This is too funny for words, which makes me th...

With the ETF industry producing new products at a furious pace, investors can implement a wide range of investing and trading strategies using ETFs. Unfortunately, most of these strategies are a bad idea. It used to be that investing in ETFs was synonymous with widely-diversified passive investing. Investors could buy XIU for Canadian stocks, VTI for U.S. stocks, and maybe a couple of others for bonds and foreign stocks, and then go to sleep for a decade. However, new ETFs are nothing like these older products. Investors who have been unhappy with their mutual fund returns can now bring their faulty investing strategies into ETFs. Many mutual fund investors used to chase the previous year’s hot fund with disastrous results. Now they can bring new hope to the ETF domain and chase the latest hot ETFs. Investors who used to try to guess the next hot sector using mutual funds can now do the same with ETFs. Unfortunately, most of them will just buy the sector hottest in the rece...

Recent research on worldwide mutual fund indexing examined explicit indexing, closet indexing, fees, and fund performance. The results are interesting. (Hat tip to the Stingy Investor for pointing out this paper.) Countries differ in the number of index funds available, and they differ in the degree to which actively-managed funds pretend to manage actively, but actually stay close to an index (closet indexers). Here are some of the findings: 1. The more explicit indexing available in a country, the lower fund fees tend to be. 2. The more closet indexing in a country, the higher fund fees tend to be. 3. The more closet indexing in a country, the worse fund performance tends to be. 4. The most actively-managed funds (furthest from closet indexing) tend to charge higher fees, but also tend to have higher returns. To oversimplify, this paper says that explicit indexing is good, closet indexing is bad, and true active management is better than closet indexing.

In Rob Carrick’s recent election wish list for investors, he led with a wish to eliminate GST on mutual funds. I share his desire to give mutual fund investors a break on mutual fund costs, but I don’t think this measure is likely to help investors much. Any time there is a reduction in the cost of providing a product or service, the savings get shared by producers and consumers. This split isn’t necessarily even, though. In very efficient markets for commodity items, most of the savings are enjoyed by the consumers. In inefficient markets, producers keep most of the savings. The mutual fund industry in Canada is competitive, but not on fees charged. Only a small slice of the industry competes on fees. The rest compete for access to customers who don’t understand fees. The bottom line is that if we eliminated the estimated annual GST of $567 million paid by mutual fund investors, there is little reason to believe that much of the savings would be passed on to investors. Mu...