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Are Long-Term Results Worth the Mutual Fund Fees?
Mutual funds have become incredibly popular investment vehicles over the past 30 years. They are promoted as efficient ways to invest in stocks and bonds, in Canada and global markets, and are available from almost every financial institution. There are literally tens of thousand of mutual funds to choose from, and no shortage of advice provided on which funds to buy. But, as an investor, the biggest question you should ask yourself is: Are mutual funds worth the fees charged? Let’s examine this so you can make a sound decision.
I spent the first 14 years of my career providing mutual funds to investors. The next 3 years I worked as a regional sales director for one of the largest bank-owned mutual fund companies in Canada.
How Much are Mutual Fund Fees?
The average Canadian mutual fund charges an annual MER, or fee, of 2.39% per annum. For example if you own $100,000 in the average mutual fund, you will pay $2,390 per year, meaning the fund will have to earn 2.39% over that time span just for you to break even. The fee is charged quarterly. Most investors do not notice this because the price of the mutual fund is adjusted to reflect the fee. It is quite possible that the largest “bill” a person will pay every year is the fee for management of mutual funds. Let’s say you are getting ready to retire, and have saved up $500,000 to supplement retirement income. If the 500K is invested in the average mutual fund, you will pay almost $12,000 per year in fees, and the fees keep climbing as your totals grow. Ouch! So if you are averaging almost $1,000 per month to have your funds managed, logically you had better be getting something of at least equal or greater value out of it, right?
Long-Term Studies Reveal the Truth
There is a gentleman named John Bogle who is a legend in the investment industry.Many decades ago, Mr. Bogle was a part of the financial system. He recognized that investors were not getting a fair deal on investment products, and created a company based on doing the exact opposite of what the financial system was telling everyone, called Vanguard. Once John started to become successful, he created the Bogle Financial Markets Research Center. He wanted to find out if mutual funds are worth the fees paid over the long run. He examined every US mutual fund from 1970-2000, which is a 30-yr span, which is about how long the average retirement lasts. Out of the 355 mutual funds available in 1970, 186 were not even around in the year 2000. That is more than 50% of funds gone. Of the 169 remaining funds, he examined how many actually beat the S&P 500 index, and the answer was astounding: 9. So, in 1970 you could have chosen any one of 355 funds, and only 9 were actually worth the fees paid, or approximately 3%. This means that 97% of the time an investor was not receiving value for fees paid! See the graphic below:
The study above is a small sample. In fact every similar study I have seen in my 23+ year career reveals pretty much the same thing- that mutual funds are, the overwhelmingly vast majority of the time, not worth purchasing.
Why Short-Term Studies Can be Deceiving
When mutual fund track records are published, we see 1, 3, 5, and 10 year results. And you will see mutual funds that outperformed the market over these shorter-term horizons. Funds will be recommended to investors based on these track records. There are some potentially huge problems here that could cost an investor a lot of money. First, unless you are aged 70+, most investors have a longer time horizon than 10 years. More like 30+ yrs. Second, a mutual fund can easily have a great year or two (or five), or the fund’s style (growth, value, etc) could be an outperformer over these shorter time periods, and then underperform over the next 5-10 yrs. The time you are most likely to buy is when a fund has had recent outperformance which could in fact be the worst time to buy.
As Canadians, we are just waking up to the fact that huge portions of our rightful retirement earnings are being handed over to the financial system, with zero value received in return. If you have not viewed the video at the top of this article, I would recommend doing so now, to help you understand what is going on across Canada.
What Can an Investor Do??
There are a number of potential solutions to save fees and put more of the gains in your pocket. Too many to list here. However, the logical question an investor should ask, after viewing all of the overwhelming information, is if we should ever own a mutual fund. The answer would seem, at least 97% of the time, no.
ETFs and low-cost index funds might be a good start.
There seems to be overwhelming evidence to support never owning mutual funds. Fees are simply too high, and are impossible to justify, over the long run. Owning low-cost ETFs and Index Funds would seem to be a superior choice. As an investor, make it a point to understand exactly what you are paying in fees, where it goes, and if what you receive in return is worthwhile.