Short answer. YES!
Here’s the math. According to Morningstar, a financial website that knows everything about mutual funds and index funds, the average mutual fund in Canada has a Management Expense Ratio of 2.5%. That means for every dollar you have invested with this fund, they take 2.5% away each and every year.
So if you give them $1000 in 2016, and the fund doesn’t make any money during the year, you lose the 2.5% or $25 and end up with $975. In 2017, if they make a 5% return, you get to keep 2.5% and they keep the other half.
Half of your profit is gone. Many market watchers expect future returns to be in the 5-7% range per year. If that’s the case, do you really want to give away almost half your profit each and every year?
Now if the mutual fund can do much better than the expected 5-7% and beat the market by a lot every year, then it’s a good deal to pay them 2.5%. Problem is, it’s really really hard for the mutual fund people to beat the market by enough so that you are better off compared to buying a low cost index fund offered by a company like Vanguard.
In fact, around 75% of mutual funds don’t beat the market and of the other 25% that do, it’s next to impossible to predict if they will be there 5 years from now. Chances are they’ll start to under perform the market, right after you gave them your money.
So you have a choice, gamble on finding that fund that consistently beats the overall market and pray you don’t pick wrong, or buy the low cost index fund that clobbers the odds and lowers your risk.
For example, Vanguard’s VCN – Canada All Cap Index fund owns the 231 largest public companies in Canada. That includes banks, insurance companies, cable and telephone companies, grocery stores, tech companies, oil and mining companies, health care companies and so. You are buying the best and brightest that Canada has to offer.
And how much does it cost to buy Canada? Would you believe .05% or 50 times less than the average mutual fund! No wonder Vanguard’s fund beats the vast majority of mutual funds.
So how do we get to the $250,000 figure? Here are the assumptions. Your family income is $90,000 year and you set aside 10% or $9000/year for retirement for 40 years.
You invest in low cost index funds like Vanguard’s VCN and you beat the high fee mutual funds by 1.6% per year, which according to The Economist magazine, is the amount that mutual funds have lagged the market in the USA over the past 20 years.
If you take the yearly $9000 contribution and suck out the 1.6% average loss you can expect by buying the average performing mutual fund, you end up with $250,157 less vs. buying the low cost index fund.
For folks with a family income of $150,000 who save 10% a year for retirement, the savings is close to $400,000!
There’s a reason why many call buying mutual funds a loser’s game. You lose and the mutual fund companies laugh all the way to the bank.
I’m a department head for a high school in Toronto. I graduated from the Ivey School of Business at Western University and have been a DIY investor for over 20 years.