Monday, September 12, 2005

Dividend Investing - My No Mutual Fund Rule

First off, a big thank you to Chad at "Twenty Something Finance" and farhan for their comments in relation to the post on my investing principles. To provide some background to those of you who did not read the comments, their questions were concerning my rule that I avoid mutual funds in my portfolio. Farhan asked why I avoid funds since some index funds also have low MERs. Chad did not agree with me that mutual funds should be avoided, and made the case that the MERs are a small price to pay for the time fund managers spend seeking out opportunistic investments and that they have quicker access to information than the average investor. He mentioned that he has been successful (i.e. beat the benchmark) with his strategy over the past five years.

In the spirit of discussion, I would like to make a couple of points here.
Farhan rightly pointed out that some mutual funds can pay very low expense ratios - specifically those mutual funds that track the indices. I think that is a great comment and I believe my statement about no mutual funds is probably too broad. My key point was that most mutual funds are too expensive for the returns they offer. I believe this article sums up the impacts of higher MERs on fund returns:
  • Morningstar notes a correlation between low MERs and high rankings on its five-star fund-rating system. The average fund in the four- and five-star categories had an MER of 2.3 per cent, while three-star funds had an average 2.5 per cent MER and one- and two-star funds had an average MER of 2.78 per cent. (Source: here)
The point the author is trying to make is that the MER is very important in determining the quality of the fund. The higher the MER, the less likely the fund is going to be a top performer.

There are mutual funds with low MERs. In Canada, TD efunds offer low cost index funds that are pretty comparable to the iUnits ETFs. In the US, Vanguard's Total Stock Market Index Fund Investor Shares has an expense ratio of 0.19%. These are great choices for a cost conscious investor.

In summary, my point (although poorly articulated in my original post) is that I avoid mutual funds with high MERs in favor of low cost investment alternatives because I believe that I do not get what I pay for on high MER funds. Many investors will do very well with mutual funds and will continue to do so in the future.

Thank you so much for the comments. Please feel free to do so...I look forward to hearing many different viewpoints.




5 Comments:

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9/12/2005 02:59:00 PM  
Anonymous Farhan said...

Great clarification. The reason I choose the mutual funds which track the indexes instead of the ETFs is obvious. Comissions! I'm buying these mutual funds on a bi-weekly basis with my RRSP contributions.

However, I am considering ETFs for investments outside of my retirement portfolio.

Here's how I did it:
1. Go to http://www.globefund.com
2. Click on Fund Filter
3. Change Load Type to "No load"
4. Change Include Index Funds to "Index Funds"
5. Hit Go
6. Click on the Key Facts tab.
7. Click on the MER% header.

Now you have all the funds sorted by lowest MER. Disregard the iUnits ETFs (you can easily see that they have no minimum investment), and everything else is a mutual fund.

TD is the cheapest :)

9/12/2005 06:32:00 PM  
Blogger thc said...

You should look at more than just expense ratios and returns. Some actively managed funds only capture 50-75% of the upside of their benchmarks but do so with a very low beta.

9/12/2005 07:06:00 PM  
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