The data is clear.
And self-directed investors want a better option.
Mutual funds have become extremely popular among a variety of investors. These investors choose mutual fund because of the simplicity and diversification mutual funds offer, but the question arises: is mutual fund indeed a good investment option or are there any other options that could achieve similar results but more cost efficient?
The fees associated with actively managed mutual funds can eat away at your investment returns and there are better options out there.
What is Mutual Fund
Mutual fund is an investment vehicle that pools investors’ money together and invests it in financial instruments such as stocks and bonds to generate returns. Financial institutions who manage these mutual funds will typically charge a fixed management fee, regardless of the performance.
To understand the mechanism behind mutual funds, we first need to know its incentive structure.
Mutual funds are structured to make sure that they always make money via fees regardless of the portfolio performance. This is infuriating because there is a conflict of interest. If you walk into a bank or advisory service, it's in their best interest to layer on fees where they can or convince you to buy products you might not need. It’s their business.
Investors are looking for the most cost-efficient way to invest their money and grow their portfolio to reach their financial objectives. On the other hand, mutual funds focus more on selling their products which is their income stream.
Even though the priorities of both party is different, the two objectives don’t necessarily always collide because mutual funds need good performance to attract investors. However, the question then becomes: is the high fees you pay to mutual funds worth it?
Mutual Funds Historical Performance
As of December 31, 2020, data from S&P Global shows that the 10-year average mutual fund return for funds tracking Canadian Equity via the TSX composite was 5.76%.
Meanwhile, the average return of the TSX composite index was 9.62%. Investors are paying an egregious fee for a terrible underperformance. In the chart below, one could see the historical performance of mutual funds that focus on U.S. large-cap stock and of SPY, the largest ETF in the world that tracks the S&P 500.
It's clear that the index fund is beating mutual funds on different long-term time span Furthermore, these are just returns from the share price, not including the 1.5% dividend you will get with index funds.
In Canada, 88% of Canadian Equity Funds underperformed their benchmark in 2020, in line with the 84% that did so over the past 10 years.
On an equal-weighted basis, Canadian Equity funds returned a bleak 4.8% below the S&P/TSX Composite over the past year.
Even with the disappointing return, average annual MER (fee) Canada for equity mutual funds is 2.23% and is among the highest fees in the world according to Morningstar.
So, what are some more cost-efficient investment options?
Alternative Options of Mutual Funds
Passive Index Investing
The first option is to invest in low-cost index funds.
It requires no fundamental stock picking analysis skills, and your portfolio will be well diversified into thousands of global companies for a lower fees and better performance.
In our model portfolio section, we listed both Canadian and U.S. listed index ETF that you could buy on any brokerage account.
It also provides the historical performance of these index ETFs and their dividend yield.
Managing a self-directed portfolio (our platform helps with this)
If you are the person who wants to own your finances, and own individual companies you believe in, this option can be best for you.
This requires doing some research, investing in high quality individual stocks, and holding them long-term.
This requires more effort and time but no management fees.
And, there are platforms like ours that can give you the analytics and research you need to make informed decisions.
Here at Stratosphere Investing, we have a great company search function where you could look at 10-years historical financials of any U.S. or Canadian listed companies, find meaningful financial metrics and more.
We also offer 50+ research reports that our Equity Analyst wrote for your convenience.
In these reports, we discuss the company’s basics, competitive advantages, future outlooks, risks, and bottom line which are extremely insightful for someone who wants to learn more about high-quality companies.
In addition, in our Model Portfolio section, we have built four portfolios for different needs. These portfolios could be an excellent starting point for investors who are planning to build their own portfolios. They are actively managed as we modify our holdings according to market movement and news.
You can also look at portfolio historical performance and news of these portfolio companies in our website.
The Bottom Line
In a world where access to low-cost self directed investing options, mutual funds are no longer great vehicles for most people.
Investors should look elsewhere to find alternative options that is more cost-efficient and provides a better investment return by avoiding lousy performance for expensive management fees.
Index ETFs is a great substitute because it outperforms mutual funds historically and charges much cheaper fees while providing the same simplicity and diversification.
Alternatively, investors could also do their own research and invest in high-quality companies long-term using a platform like Stratosphere to conduct your research.