The pros and cons of mutual funds and ETFs

Watch out for trading fees and commissions

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TORONTO – When it comes to whether to buy an exchange-traded fund or a mutual fund, financial adviser Jeanette Brox likens it to setting up a will.

While you could go it alone and save some money, she says, without professional guidance you might end up with diminishing returns.

The traditional mutual funds offered by most financial institutions have come under pressure from ETFs as the low-cost, diversified instruments have emerged as an alternative.

Both kinds of investments take a broad approach to investing, bundling together different kinds of financial products including stocks, bonds and fixed-income securities in order to minimize risk.

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Yet unlike many mutual funds, which are usually managed and shaped by financial professionals, most ETFs are pegged to a particular index, a passive and hands-off approach that reduces overhead and therefore fees.

Brox, a senior financial consultant at Investors Group, says the management fees for mutual funds are worth it for investors who want professional help.

“Most people don’t have the inclination or time,” she says. “They want to have a managed portfolio.”

Mutual funds still dominate the investment market in Canada. Mutual fund companies managed $1.2 trillion worth of assets at the end of June, compared with $84.7 billion worth of exchange-traded funds, according to figures compiled by the Investment Funds Institute of Canada and the Canadian ETF Association.

Brox says ETFs have their place, but that most Canadians want the simplicity of mutual funds as part of a holistic financial plan developed in partnership with a professional.

“Most people don’t have the time to do their own market research, and the majority of people want to discuss their goals,” she says.

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Jeff Kaminker, president of Frontwater Capital, said the enduring popularity of mutual funds is a reflection of conservative Canadian investing strategies.

“When it comes to investment, Canadians go with what’s comfortable,” he says, adding that while mutual funds generally come with higher fees, there’s a reason for that.

“Mutual funds have to make up a lot of territory to offset the higher expense ratios.”

Sandeep Gosal, an associate consultant at research firm Investor Economics, says it’s not easy to do an apples-to-apples comparison between mutual funds and ETFs because the prices for each can vary.

Data from Investor Economics shows that stock-based mutual funds often charge more than two per cent to manage your money, while pricing for stock-based ETFs can be as low as 0.2 per cent.

While mutual funds can have fees for buying in, buying out and extra commissions, ETFs can also bring extra costs, Gosal said. Because they are traded on exchanges, investors often need to pay trading fees, and Gosal said that some ETFs are now adding commissions, known as trailer fees, of up to 0.75 per cent.

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Financial planner Shannon Lee Simmons says there’s no right answer in choosing between ETFs and mutual funds.

While mutual funds can bring higher fees, they also come with a lot more personal attention and a much higher level of service, she says.

“It’s not a matter of one being better for the other. It’s a matter of what’s best for the individual.”

For people who don’t need any advice, she said, buying an ETF on an exchange is a more cost-effective way of investing.

For everyone else, it’s important to know what fees you’re paying and what they’re buying, Simmons says.

“You need to make sure there’s value there.”

One comment on “The pros and cons of mutual funds and ETFs

  1. “For people who don’t need any advice, she said, buying an ETF on an exchange is a more cost-effective way of investing.” I’m not sure the first part of this statement actually goes with the second part. A William Bernstein quote comes to mind.

    “”There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor… whose livelihood depends upon appearing to know.”

    I suspect many of those commenting above are the third type.

    Reply

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