Mutual funds are robbing you

Here’s how (and what to do instead)

Highlights:

• Why many Canadians could unknowingly be losing over 60% of their investments
• The thing mutual fund investors take as a good sign - which is actually a red flag
• How to plug the ‘leaky bucket’ that is draining your money

By the end of this article, you’ll know why you shouldn’t invest in mutual funds - and what to do instead.

First of all, what is a mutual fund?

Mutual funds are the most common way Canadians are investing for retirement.

But just because it’s popular doesn’t mean it’s the best choice.

The idea behind mutual funds is simple: instead of choosing stocks and bonds yourself, you buy a mutual fund that has a pre-selected mix.

The fund is managed by a team of investors who aim to choose and maintain the right ‘investment mix’.

Sounds great, right?

On the surface, it seems like a good idea - but in reality, there’s a dark side to mutual funds. And it can derail your retirement

76% of Canadians are realizing they need to work longer to retire comfortably.

But that doesn’t have to be you!

Keep reading to find out how mutual funds are unknowingly affecting you, and what to do instead to protect and grow your retirement fund.

The management fees are gutting you

These fees might not seem like much at first, but boy do they add up.

In Canada, the average mutual fund management fee is over 2%. Sounds like nothing, right?

And when you start investing, isn’t much - but over time, it adds up to a SHOCKING amount of money.

You can easily miss out on hundreds of thousands of dollars over your lifetime.

Here’s an example:

Meet twins Joe and Phoebe.

A few years after graduating from university and getting their first “real jobs”, they both start saving $1000 a month for retirement.

Joe chooses an index fund ETF with a management fee of 0.2%. His average return ends up being 7.62%.

Phoebe uses a mutual fund with a management fee of 2%. Her total return is 5.64%.

So how do things look in 30 years?

At this point, they’ve both invested $420,000.

Joe’s investments have grown to $1,389,030…

But Phoebe would only have $942,461.

That’s a staggering difference. And it will dramatically affect how they live in retirement.

Phoebe lost out on nearly half a million dollars!

She has 32% less than Joe, even though they invested the same amount.

It’s all thanks to her higher fees and lower returns.

In reality, Phoebe wouldn’t even have this much - because there are hidden fees we didn’t calculate. We’ll talk about those in a minute.

The longer you’re invested in mutual funds, the more money you miss out on

That’s because it’s not just a one-time 2% fee - it’s a constant deduction from your investment year after year.

It’s like a leaky bucket that drains your money.

As John C. Bogle explains in The Retirement Gamble, “On the surface, 2 percent in fees doesn’t seem like much.

It’s natural to guess that your returns might differ by 2 percent or even 5 percent. But the math of compounding will shock you.

Assuming a fifty-year horizon, this portfolio would have lost 63% of its potential returns to fees.”

This is the situation many Canadians are unknowingly in - and these ‘silent portfolio killers’ are sacrificing their financial future.

You have to pay those expensive fees, even in a downturn

The stock market goes up and down, and so do mutual funds.

Market declines are bad enough - but mutual fund fees make them worse by kicking you when you’re down.

The value of your investments has dropped, but you still have to pay those exorbitant fees.

Fidelity states, “Just as your returns may compound over time, so may your expenses, potentially leaving you significantly short of where you expected to be financially in the future.”

Put plainly, Ramit Sethi says the “#1 enemy in investing is FEES”.

High fees combined with a market slump is a double-whammy that compounds your losses.

Ouch!

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The returns are rubbish

In investing, you don’t get what you pay for.

The Financial Post points out, “Investment products might be the only case where the best products are often the cheapest.

Study after study has shown that cost correlates negatively to performance, meaning the cheapest products usually perform best.”

With all the fees, a mutual fund would have to “perform better than a low-cost fund to generate the same returns for you.”

That quote is from the U.S. Securities and Exchange Commission, which should have warning bells ringing in your head…

Mutual fund fees are so bad that the UNITED STATES GOVERNMENT is talking about them!

So the math could work if mutual funds performed well - they don’t.

Christopher Liew, CFA sums it up:

“Despite high fees, many actively managed mutual funds in Canada often underperform their benchmarks.”

He shares that over a recent 10-year period, 96.63% of Canadian mutual funds did worse than the market average.

Someone invested in an index fund that followed the S&P 500 (the 500 largest companies in the States) would’ve had a return of 7.62%, whereas mutual funds averaged only 5.64%.

Only a small percentage of mutual funds get returns that are good enough to offset the costs

What’s the chance you’ll find the few that do well? Almost nothing.

To be fair, there are a handful of mutual funds that are “killing it” and outperforming the market.

So you just have to buy those, right? Wrong.

“Research shows that most mutual funds ranked in the top-performing 25% based on five-year returns did not remain in the top 25% in the next five years.”

It’s easy to look at a mutual fund that’s done well and think, “This is a winner!”

But in reality, it should be a red flag.

Decades of data show that if a mutual fund has a winning track record, the best days are already over.

You lose the full power of compound interest

And THIS is what turns your investments into a money-making machine!

Compound interest makes your money grow faster because you’re not just earning interest on the amount you originally invested - but also on the interest that your money made.

Here’s the magic of compound interest in action:

Say you invest $1,000 and get a 7% return.

After one year, you’d have gained $70 in interest for a total of $1,070.

The next year you earn 7% on $1,070, which turns into $1,145.

Compound interest is one of the most powerful aspects of building wealth long-term, because it creates mind-boggling exponential growth.

This is the ‘Snowball Effect’ of compound interest

Think of a snowball rolling down a hill.

It starts small, but as it rolls it picks up more snow and gets bigger and bigger.

This works best when you have low fees.

When fees are high, you lose a good chunk of that snow thanks to the ‘leaky bucket’ we talked about earlier.

Those fees strangle your growth, counteract gains, and deprive you of money that should be yours.

Hidden mutual fund costs are draining your wealth

High management fees are the most transparent costs.

But that’s just the beginning. Mutual funds include a litany of other charges that ravage your investment.

Here’s how the invisible costs add up…

Fees, fees and more fees

Put simply, “trading costs money.”

Mutual fund managers are buying and selling the stocks your mutual fund holds, desperately trying to beat (or keep up with) the market.

Every time they do, you pay brokerage fees and commissions.

You might even pay to buy mutual funds - and these charges can be as high as 5 percent! This can make a huge dent in your net worth.

You’re not fully invested

A percentage of your money isn’t invested. It’s just sitting in cash.

This cash reserve means you’re missing out on potential gains you would’ve gotten if that money had been invested.

This is known as cash drag - and it’s definitely a drag.

It hurts to think you’re paying all those management fees, just to have 5-10% of your money sitting there not earning a dime.

In fact, it’s losing money because it’s not even keeping up with inflation!

Making Cents Count warns, “Cash drag refers to the negative effect that even a small percentage of uninvested cash can have on the potential earnings of your retirement savings over time.

This phenomenon can significantly impact the growth and overall performance of your retirement portfolio.”

You are lowering your overall return - and most importantly, your retirement savings.

You could pay unexpected taxes

If you hold mutual funds outside of tax-advantaged accounts like RRSPs or TFSAs, you might be paying unnecessary taxes.

We know fund managers make lots of trades.

When they sell a stock that your mutual fund holds and make a profit, you have to pay taxes on that capital gain.

You get dinged with these taxes, even if you haven’t sold your mutual funds!

Someone is getting rich off mutual funds…

But it’s not you or me.

The people who win long-term with mutual funds are those who manage or sell them.

Even the people who did well with mutual funds could’ve done far better with other investments.

As Warren Buffet said, “It will usually be the managers who reap outsize profits, not the clients.”

Ok, mutual funds are a rip-off. What should you use instead?

What if you could have the benefits of mutual funds, without the downsides?

You can 🙂

Index fund ETFs are similar to mutual funds in that they have ‘pre-selected mixes’ of companies so you don’t have to buy individual stocks.

But they are better than mutual funds because they are:

✓ Affordable: They cost only fractions of a percent, so you keep more of your money!

✓ Easy to manage: You just ‘buy and hold’, without needing to sell (plus you don’t pay unnecessary taxes)

✓ You can do it yourself: If you’re reading this, you have all the skills you need to outperform your mutual funds - while saving money. Really!

Click here to find more about ETFs and how to get started investing!