The Problem with ETFs

ETF

We read everyday on the media sites and blogs across the web that Exchange Traded Funds (ETFs) are the best options for investors as they are a cheaper alternative to mutual funds and are a great way to invest. While I agree with that viewpoint, I think it is important to also consider the problem with ETFs.

This post is inspired by a comment from Monsieur Dividende on my post on The Importance of Diversification. In that article, I discussed why it is important to diversify and how studies have shown that unique risk decreases significantly even with as little as 12 stocks in a portfolio. MD made a point that once you get to a high number of holdings, say 40-50 stocks, you are better off simply owning an ETF. While I agree that most investors are better off investing using ETFs, I have a couple of counter arguments to that point.

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Recent Sell – Mutual Fund

After being a goal for long time, we finally sold majority of my wife’s expensive mutual fund holding. The fund in question is Scotia Canadian Balanced Fund, which had an expense ratio of 2.04%. That number is nothing to sneeze at and the expenses pile up over time. More details on this below. Going forward, we will be balancing our portfolios better integrated so that we align closer to our combined goals.

Why Sell?

  • Expensive fund: The fund is extremely expensive at over 2%. Two percent is a large amount of money for what is simply an index tracking fund. To put things into perspective, for every $10,000 invested, that results in $200 per year. Over the course of next 30 years, that is $6,000. Now multiply that by every $10,000 invested in the fund and you will notice how the expenses can get out of hand!
  • Lack of diversification: Another important factor in selling this fund is the lack of diversification. The fund is invested completely in the Canadian market (55% in stocks and 45% in bonds). While the stock/bond diversification is good, we are exposed too highly to one country (Canada) and any recession or economic hardship hitting Canada will result in serious under-performance and loss of our hard earned money.

Investment Strategy

We will be using the cash from this sale to invest in index funds via ETFs. ETFs are a lot more inexpensive (its not uncommon to find a fund tracking S&P/TSX for 0.05%) and we will also be picking more than one or two funds to achieve some diversification in exposure to both stocks and bonds. We are also planning on keeping things simple so that my wife can maintain the portfolio going forward. Overall, the plan is to maintain a simple diversified index fund based portfolio in my wife’s account while I invest in individual stocks of blue chip companies.

In the coming days, I will be posting details of which funds we will be picking for the investment in this account. Stay tuned!

Boost Your Income With These ETFs

The stock market continues to linger close to the all-time high while the interest rates continue to hold at an all-time low. There is still no clear indication from the Fed on when the interest rates will rise – leaving risk-averse investors with paltry returns on cash and bond holdings. In the recent years, investors have rotated out of bonds and piled into the equities market driving up the stock prices. With most of the stocks either fully priced or overvalued, investors yearning for income have had to turn to alternate strategies. This article discusses one such strategy.

Continue reading the full article.

A Scam Called Mutual Fund

If there is any universal piece of advice in the investing world, it should be – “Stay away from mutual funds”.
Mutual funds come with a a little hidden number called MER – the Management Expense Ratio – which looks measly to begin with ranging from 1%-3% (some mutual funds may be as high as 5%).

Do not get fooled by this number because this number is a recurring annual fee and is taken off the overall returns of the fund, so you never see it anywhere on your semi-annual or annual statements reminding you that you just gave a major part of your savings to the fund company.

The Solution

  1. If you are looking for diversification without picking individual stocks, invest using an ETF – Exchange Traded Fund. The ETF fees normally vary from 0.05% to 0.8%. 
  2. A better option is to build your own portfolio. You pay a one time trading fee and no other recurring fees. You have two options – either direct investing via a DRIP plan or through an online discount broker.

Use Case

To best illustrate my point, lets assume you decided to invest in a mutual fund:

  • Initial investment: $10,000
  • Subsequent investments: None
  • Rate of investment return: 5%
  • Mutual fund MER = 2%  (which is a conservative estimate of the funds available in the market).
  • ETF MER = 0.5%
  • Stock investing via DRIP – assuming you buy 10 companies and setup direct investing – the only expense would be the cost associated with obtaining the first share from your peers (which is usually $10).
  • Stock investing via discount brokerage – assuming you buy 10 companies and a trading fee of $4.95 per trade (as offered by Questrade).
Mutual Fund Fees ETF Fees DRIP Investing Brokerage Fees
After 1 year $807 $52 $100 $49.50
After 5 years $1,444 $315 $100 $49.50
After 10 years $2,605 $796 $100 $49.50
After 20 years $6,849 $2,530 $100 $49.50

ETF fees also add up over time, but no where near the rate of mutual fund fees. So, if you are looking for diversification with a fund, it is no brainer to choose ETFs.
If keeping your fees down is your ultimate goal, direct investing either via DRIP or online discount broker is your best option.

If you own mutual funds and wish to find out how much your funds are costing you, click here for a great tool.

Disclosure: I owned about 6 mutual funds until I started realizing the snowballing effects of the fees. I have started trimming them down and currently own two mutual funds. I am hoping to cut back on those two funds in the near future.

Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.