Three factors are driving this shift in investor behaviour. First, there is growing awareness that high costs embedded in mutual funds can severely limit their long-term returns. For example, consider an equity mutual fund with a typical 2% management expense ratio (MER), which earns an average compound annual return of 6% before costs. Investors selling their fund after 30 years would keep less than half the fund’s pre-fee total compounded return with the rest consumed by fees. In contrast, investors in an index ETF with a typical 0.20% MER with the same 6% pre-fee return over 30 years would retain over 90% of the total return (you can run your own scenarios on the T-Rex Score calculator). Second, there are more ETFs from more sponsors than ever before and the list is growing. Third, the same big banks that dominate the mutual fund business have become the leading providers of ETFs and the online platforms that provide easy access to them.
Watch: ETFs vs. Mutual Funds fees
Most index funds are ETFs, but many ETFs are not index funds
Many people are under the false impression that all ETFs are low-cost index trackers. Not so. But it is true that the largest and most liquid ETFs are index funds that track the performance of a stock index, like the S&P 500, or a bond index like the FTSE Canada Universe Bond Index. There are also “all-in-one” ETFs offered by a number of providers which package several index funds tracking diversified Canadian, U.S., and global stock and bond indexes. These convenient all-in-one ETFs come in graduated stock/bond combinations, including 80/20, 60/40, 40/60 and 20/80.
These two classes of ETFs—single-index trackers and all-in-one ETFs—offer low cost, diversification, liquidity, choice of sponsor and convenience. There are also hundreds of higher-cost ETFs, including those focused on narrow sectors like gold, cannabis or crypto, as well as “actively managed” ETFs created by the big mutual fund providers to maintain their overall market share as growth of ETFs eclipses mutual funds.
In fairness to mutual funds, there are many low-cost index mutual funds available as well, but ETFs tend to have lower costs than passive index mutual funds. Most mutual funds remain active funds with higher fees. Most ETFs are passive funds with lower fees. The point is you cannot paint all funds with the same brush.
ETFs: with or without advice?
If you plan to make the switch to ETFs, you must first decide whether you want to pay for ongoing advice and, if so, what type and frequency of advice you need.
If your portfolio amounts to several hundred thousand dollars or more, you can find full-service advisors who will assess your circumstances, recommend an asset mix, provide additional ongoing advice and invest your funds in ETFs for an annual fee typically ranging from 1% to 1.5% over and above ETF MERs (there are some advisors who charge fees of less than 1% for those with portfolios of $1 million and higher).
If your portfolio is more modest or if you want automated investing with an asset allocation that matches your needs, there are a number of robo-advisors typically charging 0.25% to 0.50% annually on top of MERs of the mix of diversified ETFs they will manage on your behalf. This represents savings of 0.5% to 1.25% compared to a full-service advisor, albeit with less human interaction and advice.
If you have a good understanding of investment basics and have at least $25,000 or so to invest, you could efficiently create your own ETF portfolio through an online discount broker. Assuming you are a long-term, “buy and hold” style investor, your only significant cost will be the MERs of your ETFs. If you choose this route, or just want to check it out, try the “practice” trading accounts offered by many online brokers.