One of the most common debates in the financial industry is around mutual funds: sensible investment vehicle or money-sucking rip off?
Over my 25 years in banking and finance, my own opinions of these investments have waxed and waned. When I was fresh out of university, I was selling them in a TD Bank branch, and loved it. Later, I spent 15 years working in portfolio management, picking stocks for the TD Mutual Funds. During that time, I was conflicted: mutual funds were doing a good thing for many people, but I couldn't shake the thought that there were cheaper options for investing that would perform at least as well.
So what's the real deal with mutual funds?
The good
Mutual funds democratized the stock market, making investing accessible to more people, and this was a very good thing. Before the popularization of mutual funds in the 1950’s, it was harder to get your money invested in the stock market. You needed a stock broker to buy stocks for you and you needed a fair amount of money to do it.
The murky
There are three reasons why mutual funds get a bad rap:
- Sales practices
- High fees
- Mediocre performance
Sales practices around mutual funds have a muddied history. Investment advisors who are making recommendations to their clients about what to invest in might be influenced by sales commissions, and worse these commissions (and other perks that used to be permitted) weren't always properly disclosed to investors. Mutual fund sales people had credibility issues.
Traditional mutual funds can be expensive to own. Paying fees to own a professionally-managed mutual fund isn’t the problem - the concern is around the trailer fee. A trailer fee is the portion of the mutual fund fees you pay that goes to the financial advisor for giving you advice, and that advice hasn't always lived up to the fees investors pay.
Despite the fact that you are paying professional money managers to make all the investment decisions, the fund might not perform well. In fact, the majority of funds do not perform better than the overall market.* This is because picking winning stocks is really hard to do consistently.
One of many options
Should you feel like a sucker for investing in mutual funds? No. Being invested in traditional mutual funds is better than not being invested at all. Paying mutual fund fees to have your money in the stock market should have made you more money than letting your money sit in a savings account or a GIC. Also, despite a less-than-perfect reputation, I can tell you that the mutual fund industry is full of good people. I've worked and been friends with many of them.
For anyone who is willing to go beyond the simplicity of buying a mutual fund, there are lower-cost options that are just as effective. Check out my other blog posts here.
* According to S&P, 95% of Canadian Equity mutual funds did not perform better than the overall Canadian market over the pas give years, as measured by the S&P/TSX Composite Index. You would have been better off owning an ETF that mirrors the market. Source: S&P Global 2021 SPIVA report.
