PETER DOLEZAL: A guide to your options on mutual funds

Historically, mutual funds have been the way to achieve investment product diversification

Historically, mutual funds have been the way to achieve investment product diversification, albeit at a price. Until the late 1990s they were the only option available to the investor wanting to achieve quick and easy diversification of product, sector and geography. Even David Chilton in his famous early ‘90s book, The Wealthy Barber, recommended the use of such funds.

Today, an investor is no longer held hostage to the high-cost mutual fund industry. Unfortunately, a majority of Canadians do not yet understand that Exchange-Traded Funds (ETFs) and Index Funds can deliver the same diversification benefit as do mutual funds, but at a small fraction of the cost. Nor do they often understand such funds, which track a specific index rather than trying to beat it, routinely outperform comparable mutual funds by a substantial margin — often approximating the difference in fees.

It is interesting to note that once one has taken the time to understand the benefits and fee differences between mutual funds and ETF and Index fund options, the investor usually moves to the latter vehicles and abandons previous mutual fund strategies.

Until Canadian Securities Regulators finally implement long-contemplated mutual fund disclosure rules and force the industry to adhere to them, the typical mutual fund buyer simply nods his head when an advisor recommends a mutual fund purchase. Somewhere in the sheaf of paperwork he signs for the advisor, will be an outline of the annual Management Expense Ratio (MER) fees and other embedded costs. Very few mutual fund investors are aware that their Canadian mutual fund can be costing them, on average, 2.4 per cent of their fund value in annual fees. It is also highly unlikely investors in mutual funds are aware the advisor recommending such funds stands to personally earn up to half of that fee as an annual “trailer” fee. In any other business, the advisor would be considered to have a huge conflict of interest — why is this not so in the mutual fund industry?

By all means, do consider the purchase of a recommended mutual fund. But, until regulators force the industry to make full, easily-understood disclosure, insist  before you agree to a purchase that the advisor inform you of all the annual holding costs associated with the purchase — as well as his or her personal gain from  your holding. Also, beware of extra costs in the form of “front-end” loads or “back-end” loads which, in addition to the high MER, can add up to five per cent to the cost of the fund.

Before visiting the advisor, inform yourself on the various options available. Before you agree to a recommended investment, be prepared to ask tough questions,

 

A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books.