Friday, 11 March 2016

Comparison: Mutual Funds vs ETFs



By now, hopefully everyone has at least heard of ETFs or Exchanged Traded Funds.  We could call them the cousin of the Mutual Fund.  The ETF industry has grown a lot over the years but is still a distinct second in the race for Canadian Investor's dollars.  In 2015, ETFs did do record sales but only accounted for about 10% of the market in terms of Investor's Dollars.  Without further delay, here are key points in the difference between Mutual Funds and ETFs:

Mutual Funds

  • Can be purchased at most banks and other financial institutions or self directed accounts
  • Holds securities usually dictated by the direction of the fund, usually in the hundreds
  • Average MERs or Management Expense Ratios for Mutual Funds in 2015 was 2.3%
  • Usually includes front end (when you buy) or back end fees (when you sell) 
  • The advisor gets from the fees called a Trailer Fee
  • Price of the Mutual Fund is determined at the end of the day
ETFs
  • Can be purchased only using a self directed account or until recently using the BMO Smartfolio products.
  • Can hold securities dictated by the theme of the ETF but can also be very focused in their selection, sometimes holding only 6 stocks.
  • ETF fees are amazingly small, an index ETF can be had for as low as 0.2% vs it's mutual fund counterpart Index fund' MER of 2.1%
  • There are no front end, back end or trailer fees.
  • You do have to pay the commission to buy, which currently all banks have their brokerage fees at $10 or less
  • Is traded like a stock so there is a ticker and can be bought and sold several times in a day.
  • Dividends are yours to keep or can be setup in a DRIP (dividend re-investment plan)
Final Thoughts

The biggest difference between Mutual Funds and ETFs is for sure the Fees.  The banks are very quick to advertise the magic of compounding and how if you hold your Mutual Fund for 20 years, $1,000 will grow to this number.  That is true but they never talk about how the Fees are also compounded.  The magic of compounding fees can be summed up this example : a portfolio of mutual funds totally $500,000 will pay a fee of $11,500 a year (using the average of 2.3% in 2015).  Assuming no new money is added during a 10 year period, the total fees in 10 years will total $111,500 assuming no compounding.  Now do that math again, it is a true number.  Do you know that you are spending this amount in fees in a 10 year period?  This is only at the bank level where you get $500 automatically taken out of your account and divided among the mutual funds they asked you to pick.  If you had a financial advisor who would pick the funds for you, tack on an additional 1% to bring the fees to about 3.3% a year.

ETFs are definitely better for the average investor but ETFs can only be purchased using a self directed account.  Most investors think buying and selling ETFs is hard.  In my experience, setting up the appointment at the bank and signing the papers was the hardest part.  If you bank online, you can invest online using a self directed account.  

BMO Smartfolio is a bank product which enables investors to not open a self directed account but can gain access to ETFs and their low fees similar to a mutual fund setup through automatic withdrawals.  The BMO Smartfolio gives investors the ability to access lower ETF fees with a big of hand holding since they only offer BMO ETFs.

To buy and ETF, you only pay the $10 and put in your order.  If you were to buy $10,000 worth of a mutual fund, you would pay $230 every year as long as you hold the mutual fund.  If you were to buy the same type of ETF, you would pay $10 for the $10,000 but the ongoing fee would probably be in the area of 0.5% or $50 a year.  Now that is comparison shopping there.  $230 vs $50.  I bet most people would go with the $50 but then again they spend more time deciding on $1.99 or $2.49 toothpaste.

Selling a mutual fund sucks.  It's like it is stuck in the 1980's.  If you want to sell a Mutual fund, you need to call in, identify yourself and then tell them you want to sell the fund, but be warned, get this call in before 11:00 am or you won't get the price at the end of the day at 4:00 pm.  With ETFs, the price is listed instantly and you can decide to buy or sell right there.  Just like online banking.

Last thought, more Canadians need to understand that there is a better fee for your investments and the quicker they understand, the quicker they can invest their way without fees holding them back ($110,000 in 10 years)