Barry Cerny, 53
Retired air-traffic controller
Fairmont Hot Springs, B.C.
I grew up in Calgary and lived there all my life. I started as an air-traffic controller when I was 21, and after 30 years I wanted out. My wife Kim and I moved out here when I retired two years ago, so we could enjoy hiking, biking, kayaking, windsurfing, golfing, you name it.
I look after the finances for both of us, and I have always invested directly with mutual fund companies. About five years ago I put Kim’s investments in Mawer mutual funds, and I moved my own account there three years ago. Before that I was with Phillips, Hager & North, another good company with low fees.
I’ve pretty much been my own adviser with Mawer. Nobody pushes me to invest in something I don’t want, like stockbrokers I’ve had. They’re hands-off: they don’t contact me unless I contact them.
Before I switched to funds, I had a discount brokerage account and I was trading some individual stocks. It was okay, but it just never went that well for me. I’m more comfortable where I am now, with low-cost mutual funds that have a good record. I like that the funds are professionally managed by analysts who are watching the stocks every day.
No financial product has had more impact on small investors than mutual funds. It’s easy to see why. They offer Joe and Jane Investor a chance to hold entire portfolios of stocks and bonds that they could never have assembled on their own. They’re easy to buy, either through your bank or through an investment adviser. And best of all, it’s a snap to set up automatic contributions to your funds every month, which makes saving almost painless.
Actively managed mutual funds also give investors the opportunity to earn market-beating returns and get protection from big losses during bear markets. This gives many people comfort—knowing that their money is being managed by a professional can make them less likely to bail during a downturn.
“I believe that mutual funds and advice are needed,” says Ken Kivenko, an investor advocate and the creator of CanadianFundWatch.com, adding that many people simply aren’t equipped to invest on their own without some professional help. But he warns that mutual fund investors face hurdles. “It’s possible to be successful, but you need to protect yourself. The bear traps are everywhere.” Here’s how you can avoid them:
Choose only low-cost funds. Canadian mutual funds often charge a management expense ratio (MER) of 2% to 3%, among the highest in the world. Even a 2% fee means you’re paying $1,000 a year for someone to manage a $50,000 portfolio, and over a lifetime that can easily eat up one-third of your returns before costs. As a rule, you shouldn’t pay more than 1% for a bond fund, or more than 1.5% for an equity fund. Insist that your adviser tell you the MER of every fund in your portfolio and ask if there are lower-cost alternatives. Don’t make the mistake of thinking that higher fees mean better management, and therefore higher returns. The reality is almost always the opposite.
Use an unbiased adviser. Kivenko argues that when mutual fund dealers are paid by commission—and most of them are—they have an inherent conflict of interest. A fee-for-service financial planner—who is paid directly and transparently by you—can provide unbiased recommendations for low-cost funds, as well as comprehensive retirement and tax planning. (See MoneySense.ca for a list of fee-only advisers.)
Consider investing on your own. Buying mutual funds on your own takes about as much financial savvy as paying your bills online. You can open an account directly with a low-cost fund provider such as Mawer, Steadyhand or Phillips, Hager & North and set up an automatic contribution plan. (Minimum account sizes range from $10,000 to $50,000.) Or you can assemble your own portfolio by opening a discount brokerage account through your bank. This will allow you to buy “D Class” funds, which do not have embedded fees earmarked for advisers. Using either of these methods, you can build a mutual fund portfolio with an annual cost of about 1%, less than half what you’d pay through an adviser.
Take a load off. “Loads” are mutual fund sales charges, and they come in two forms. Some funds charge a front-end load, an upfront fee of about 5%. Others levy a deferred sales charge (DSC), which is deducted when you sell the fund. DSCs typically start at 6% if you sell the fund within the first 12 months and get gradually lower for several years until they finally hit zero. Whether you choose to work with an adviser or on your own, it’s not necessary to pay these fees. There are plenty of no-load funds available, even from the big banks.
Monitor your performance. Kivenko suggests asking your adviser for your personal rate of return at least once per year. This isn’t as straightforward as it may sound. If you’re making monthly contributions, it’s difficult to know how much of your portfolio growth is from investment returns and how much is simply the money you’ve added. “A lot of advisers don’t understand how to do dollar-weighted returns,” Kivenko says. “But if you are in the business of giving advice, then a minimum requirement should be the ability to measure that advice.” Compare your personal rate of return with the appropriate benchmark: for example, compare your Canadian equity fund to the S&P/TSX Composite Total Return Index. If your funds return less than the overall market, why are you paying a fund manager?
What returns can you expect? We’ve graphed the average performance of balanced mutual funds before fees above in The complete package, above (data courtesy of Fundata Canada). The average annual return since 1980 is 10.4%, better than the appropriate mix of benchmark indexes, so the managers of these funds have definitely added value. However, as the line in dark green shows, after the fees are added in, the mutual fund performance drops below that of the Couch Potato indexing portfolio (see page 44). One thing to keep in mind is that both the Couch Potato and mutual fund strategies include bonds, so they shouldn’t be compared directly to an all-stock strategy.
What can go wrong? Even if you’re investing in low-cost funds, you still need the discipline to stick to your strategy. Investors love to chase performance by buying last year’s best performers, which virtually guarantees dismal results. According to the research firm Dalbar, equities returned 8.2% annually over the last 20 years, but typical equity mutual fund investors earned barely 3% because they jump in and out at the wrong times.
The simplest way to be a successful mutual fund investor is to buy a single no-load, low-fee balanced fund. These all-in-one portfolios contain a mix of bonds and equities suitable for an investor with a moderate risk tolerance. If you have a five figure portfolio and the discipline to make monthly contributions, it’s hard to go wrong with this strategy. These excellent funds can be purchased directly from the fund company or through a discount brokerage.
|Mutual fund||Management expense ratio (MER)|
|Mawer Canadian Balanced Retirement Savings Fund||1.01%|
|Maclean Budden Balanced Growth Fund (D Series)||1.00%|
|PH&N Monthly Income Fund (D Series)||1.05%*|
|* Estimated MER. It is possible that the actual MER audited as of December 31, 2010 may differ.|