Most Canadian investors use a financial advisor to help them make investment decisions and, more often than not, the advisor directs their clients’ investments toward mutual funds with a high management expense ratio (MER).
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, more and more 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 2.14 and 2.42 per cent. 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 per cent 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:
|Fund||MER||Ten-Year Growth of $10,000|
|TD Canadian Index e-series||0.33%||$20,132|
|TD Canadian Equity||2.18%||$19,286|
|RBC Canadian Index||0.71%||$19,056|
|RBC Canadian Equity||2.42%||$15,644|
|Scotia Canadian Index||0.99%||$18,801|
|Scotia Canadian Growth||2.14%||$12,613|
|BMO Canadian Equity ETF Fund||1.01%||$17,834|
|CIBC Canadian Index||1.12%||$18,445|
|CIBC Canadian Equity||2.33%||$13,551|
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 80 per cent of actively managed mutual funds over the long term. Unfortunately, index funds are not marketed very well by the financial industry, as advisor’s 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 away by unnecessary fees.