This article was originally published two years ago and is one of the most widely read investing pieces on Boomer & Echo. I’ve updated the 10-year returns of the funds listed below. Not surprisingly, the returns of low cost index funds still beat the more expensive equity funds.
Despite numerous studies showing that Canadian mutual fund fees are among the highest in the world, and that actively managed mutual funds tend to perform worse than low cost index funds, many Canadians continue to invest their money in expensive funds.
Index Funds vs. Equity Mutual Funds
The equity mutual funds offered by the big banks have management expense ratios (MERs) between 2.06 and 2.40 percent. They are sold to investors as a way to beat the market by using a professional management team to actively manage the portfolio.
Conversely, index funds are designed to track a specific index and deliver market returns, minus fees, which are typically around 1 percent or less.
I looked at the mutual funds that are offered at each of the 5 big banks and compared the 10-year performance of high cost Canadian equity mutual funds to the equivalent low-cost index funds.
Here are the results from May 2004 – May 2014:
|Fund||MER||10-year growth of $10,000||Annual return|
|TD Canadian Index e-series||0.33%||$22,700||8.54%|
|TD Canadian Equity||2.19%||$22,461||8.43%|
|RBC Canadian Index||0.72%||$22,047||8.23%|
|RBC Canadian Equity||2.06%||$20,413||7.40%|
|Scotia Canadian Index||1.00%||$21,497||7.95%|
|Scotia Canadian Growth||2.14%||$16,803||5.33%|
|BMO Canadian Equity ETF||1.05%||$20,635||7.51%|
|BMO Canadian Equity||2.39%||$20,492||7.44%|
|CIBC Canadian Index||1.14%||$21,238||7.82%|
|CIBC Canadian Equity||2.40%||$16,626||5.22%|
The banking industry has led Canadian investors to believe that paying higher investment fees will result in superior returns for their portfolios. Yet in each of the five examples shown above, returns from the high MER equity mutual funds lagged behind returns from the cheaper index funds, often by a wide margin.
For decades, low cost index funds, and more recently low cost index ETFs have provided higher returns when adjusted for investment risk.
Market indexes will outperform at least 80 percent of actively managed mutual funds over the long term. Unfortunately, index funds are not marketed very well by the financial industry, as advisors have little incentive to sell them to you.
Mutual funds are still a great place for investors to start building their portfolios, but Canadian investors need to do a better job understanding the high MERs that we are paying.
You don’t have to settle for the expensive equity mutual funds recommended by your financial advisor. Ask questions, shop around for cheaper index funds, or look into ETFs as a low-cost investment alternative. Don’t let your portfolio get eaten up by unnecessary fees.