When your adviser hates index funds
When Derek asked his adviser about switching to ETFs, he got a list of reasons not to. I don’t agree with any of them.
Derek decided it was time to talk with his adviser. He’d been reading about index investing using ETFs for a few months, and he was starting to question whether he was getting his money’s worth out of his pricey mutual funds. But Derek wasn’t prepared for the pushback. “My adviser gets very defensive when I speak to him about ETFs and other options.” The last time Derek brought it up, his adviser emailed him a list of reasons why indexing is an inferior strategy. “Now he has me second-guessing myself.”
These days, advisers who sell actively managed mutual funds are being peppered with questions from an investing public that is finally waking up to the fact that they’re often being poorly served. Here are the most common objections you’re likely to hear from advisers if you ask about index funds, and some suggestions for how to respond.
“Index funds offer no chance of beating the market.”
This is true. Index funds are designed to track their benchmarks closely, but they aren’t free, so they almost always lag slightly. The point is that actively managed funds usually underperform by even more. Well-run index funds routinely finish in the top quartile over any period longer than a few years, meaning they beat at least 75% of their peers.
Actively managed mutual funds do offer the possibility of outperformance. The question is, what is the probability? According to Standard & Poor’s, less than 20% of Canadian equity funds outperformed the S&P/TSX Composite Index in 2010. Over longer periods, that percentage drops even lower. During the last five years, just 2.5% beat the market. Over 25 years, the odds your portfolio will outperform resemble your nine-year-old’s chances of playing in the NHL.
“Average fund performance may be mediocre. But we select only the best managers.”
It’s amazing that there are billions of dollars invested in poorly performing mutual funds in Canada, but no adviser ever admits to recommending them. They all live in Garrison Keillor’s Lake Wobegon, “where all the children are above average.”
Advisers love to build portfolios with five-star funds and tell their clients they own the best in the business. The question is, did they start recommending those funds before they posted excellent results? If your adviser tells you that your fund has beat its benchmark over the last 10 years, ask him whether he was recommending it in 2002.
The best managers can only be identified in hindsight. Advisers can sell past performance, but unfortunately their clients can’t buy it.