What Is The Real Cost Of A Mutual Fund?

Sometimes I am amazed that there is still a debate over investing in index mutual funds vs. actively managed mutual funds. Index funds have a proven record without the added risk.

Since the fund company had to pay the advisor the commission what they do is increase the MER of the fund by about 0.5% compared to Class A units. This means your return will be 0.5% lower each year compared to if you had bought the Class A fund. When you buy this type of fund you are also locked in for a period of seven years (time frame could vary). If you sell prior to this you have to pay a penalty to the fund company allowing them to recoup the commission they paid to the advisor. Between the locked in period and the higher MER this option is clearly not in the client’s best interest.

There are various schemes and your manager can suggest you the paramount option according to your requirement. You can start off with a very small amount which can be directly debited from your bank account on a monthly basis. You can enter this sector with a low investment and can grow steadily. Fund managers keep a track of mutual fund NAV and accordingly suggest when to sell it off. Company that maintain records are trustworthy and you can be assured that your money is safe.

“Over the last five years, only 10% of active funds in the International Equity category, 13.9% in the Global Equity category, and 9.2% in the U.S. Equity category have outpaced S&P EPAC LargeMidCap, S&P Developed LargeMidCap and S&P 500 indices respectively.” So over the last five years 93.6% of Canadian equity funds, 90.8% of US equity funds, 90% of International equity funds and 86.1% of Global equity funds have underperformed their respective indices.

It is easy to figure out why actively managed investments consistently under-perform with the incredible high Management Expense Ratio (MER) that is charged on actively managed mutual funds in Canada. Having a 2%+ MER compared to an index funds MER of 0.75% or less is a lot to overcome. Overcoming these higher fees becomes an even more difficult task when you look at the holdings of a typical equity fund compared to its index. In most cases the holding are very similar.

People buy actively managed investments with a goal of beating the index. To beat the index fund by just 1% the unique assets would have to outperform by 11%. This is why most actively managed funds have underperformed the indices in the past and will most likely continue to do so in the future Since the holdings in these funds are so similar anyways just take the lower fee index option and be happy that you should do better then an actively managed fund about 90% of the time.

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