Mutual Funds vs ETFs

[I_H8_Crawford]

So my girlfriend has been teaching me about investing since she is really into finance, and one of the things she has taught me about it MERs. (http://vixmoney.com/management-expense-ratios-mers)

After looking at Mutual Funds, the MERs are INSANELY high compared to ETFs, and as far as I understand, you can build a portfolio of ETFs to mirror virtually any Mutual Fund out there, with the added benefit of paying a significantly lower MER.

So, does anyone know why people routinely choose Mutual Funds? Are there any reasons to choose Mutual Funds over ETFs?

Or is it just a case of the average consumer doesn't know/care, and goes with what they are told by their bank/advisor (who makes more money of Mutual Funds than ETFs)?

[GP_Matt]

I know that out company if you want to participate in the company matching RRSP plan you have to have your account with Sunlife. Sunlife tailors a selection of funds that we are allowed to pick from and none of them are ETFs. You are allowed to transfer the money from Sunlife to your personal RRSP account but that is a bunch of work so most people don't bother.

[Cecil Terwilliger]

Big reason off the top of my head is that part of the MER is paying someone to look after that mutual fund and rebalance when necessary, research etc.

You could build your own portfolio all by yourself but then you would be putting in a lot more work and research. That is what you are paying the higher MER for.

[Slava]

Well thats not the entire story. The MER is higher for sure, but there are no transactional costs for a mutual fund and that is a big difference. There is an option for an ETF that doesn't cost transaction fees now, but its the extreme minority.

There are a few other factors, but when you get really sector specific the other issue is liquidity. A lot of ETFs simply aren't very liquid as compared to a mutual fund.

Another reason is that the mutual funds are actively managed whereas the ETFs (by and large) are not. As the fund buys and sells holdings the fees to operate increase and voila you have a higher MER. The ETF doesn't operate like that though and as such management fees are much smaller.

[Slava]

Oh, and another major consideration is that mutual funds do things from a tax perspective that ETFs can't match. For example converting interest income to capital gains or dividends. Sheltering investment income entirely from taxation each year and that sort of thing. Paying a higher fee to save a huge amount on taxes is entirely worth it.

[bizaro86]

Originally Posted by Cecil Terwilliger

Big reason off the top of my head is that part of the MER is paying someone to look after that mutual fund and rebalance when necessary, research etc.

You could build your own portfolio all by yourself but then you would be putting in a lot more work and research. That is what you are paying the higher MER for.

The biggest difference is the fee going to the financial advisors who sell mutual funds. It's basically the compensation for the advisor embedded into the product. (And realistically, they have to get paid like everyone else). There are some advisors around who work on a "fee-only" basis, and charge a fee either hourly or as a percentage of assets. Then you would buy "f-class" funds which don't charge the extra fee for the advisor, or break the fee out separately.

Basically, the cost of the advice is bundled into the cost of the fund. Typically with ETFs, you either don't get the advice or pay for it independently.

[Slava]

Originally Posted by bizaro86

The biggest difference is the fee going to the financial advisors who sell mutual funds. It's basically the compensation for the advisor embedded into the product. (And realistically, they have to get paid like everyone else). There are some advisors around who work on a "fee-only" basis, and charge a fee either hourly or as a percentage of assets. Then you would buy "f-class" funds which don't charge the extra fee for the advisor, or break the fee out separately.

Basically, the cost of the advice is bundled into the cost of the fund. Typically with ETFs, you either don't get the advice or pay for it independently.

I just plain disagree with you on this. While its true that there is a fee there, the reality is that someone gets paid off the ETF as well, and that includes the transaction fee to acquire the fund in the first place.

The reality is that ETFs and mutual funds are vastly different in how they're used and how they are invested in. A mutual fund is more of a buy and hold type of investment whereas ETFs aren't necessarily. In fact the average holding period for some of these instruments is about three days, whereas you can't even do that with a mutual fund, let alone whether you would want to! Then you add in the double short/double long ETFs and you have a whole other ballgame. When you really look at the instruments themselves they are really quite different, and that has nothing to do with how the compensation is paid, despite the ETF industry wanting to promote that factor.

[lazy_programmer]

Here is an interesting article about what Google did pre-IPO for their employees:

http://www.modernluxury.com/san-fran...oull-never-get

As with most things, there is no one best way and you'll need to decide for what works for you.

[CarlW]

Agree with everything that's been said so far, especially having it being managed but you should do some research in the fund managers and their performance history when looking at Mutual or Segregated Funds as not all managers are that good. Also when looking at a funds performance history make sure they are already net of MERs.

Also, Mutual funds as far as I know always has your distributions reinvested by default which is convenient.

One downside of dealing with mutual fund brokers if not buying through discount brokerage though is that if you have a bad broker you're buying it through, your sell order may not be executed when you want it to be (happened to a friend of mine, told them to sell and never sold ).

If you also wanted to know, there are also things called Segregated Funds offered by Life insurance companies that have usually 75% or 100% protected principal guarantees on contract maturity and death. These are basically the same as Mutual Funds (all have mutual fund equivalents), but have even a little bit of a higher MER (in most but not all) cases then a Mutual Fund that you're paying for the principal protection.

[linecook]

You can also get a lot of good mutual funds with low MER's. I was just reading yesterday that the majority of high MER's are not out performing any better than mutual funds with low MER's.

I've been looking at adding ETF's to the protfolio but it seems like every ETF I've looked in to has never performed very well. Doe's anyone having any suggestions for good ETF's?

[Slava]

Originally Posted by CarlW

Agree with everything that's been said so far, especially having it being managed but you should do some research in the fund managers and their performance history when looking at Mutual or Segregated Funds as not all managers are that good. Also when looking at a funds performance history make sure they are already net of MERs.

Also, Mutual funds as far as I know always has your distributions reinvested by default which is convenient.

One downside of dealing with mutual fund brokers if not buying through discount brokerage though is that if you have a bad broker you're buying it through, your sell order may not be executed when you want it to be (happened to a friend of mine, told them to sell and never sold ).

If you also wanted to know, there are also things called Segregated Funds offered by Life insurance companies that have usually 75% or 100% protected principal guarantees on contract maturity and death. These are basically the same as Mutual Funds (all have mutual fund equivalents), but have even a little bit of a higher MER (in most but not all) cases then a Mutual Fund that you're paying for the principal protection.

The seg fund has a lot of differences again though; one being that they can flow capital losses through to investors as well as capital gains. A mutual fund can't do that. There are also numerous estate planning and creditor protections afforded to segregated fund holders that are not available to mutual fund investors. Again, yes the MER tends to be higher (they aren't always), but if you have specific needs that you are addressing then there can be a lot of value to that.

[bizaro86]

Originally Posted by Slava

I just plain disagree with you on this. While its true that there is a fee there, the reality is that someone gets paid off the ETF as well, and that includes the transaction fee to acquire the fund in the first place.

The reality is that ETFs and mutual funds are vastly different in how they're used and how they are invested in. A mutual fund is more of a buy and hold type of investment whereas ETFs aren't necessarily. In fact the average holding period for some of these instruments is about three days, whereas you can't even do that with a mutual fund, let alone whether you would want to! Then you add in the double short/double long ETFs and you have a whole other ballgame. When you really look at the instruments themselves they are really quite different, and that has nothing to do with how the compensation is paid, despite the ETF industry wanting to promote that factor.

For sure those double short double long exotic ETFs are just plain financial weapons of mass destruction. I was talking more about comparing a "regular" big cap mutual fund to something like XIC, which basically just buys the TSX composite index. That's what I use for long term diversified investing. With a 0.27% MER, $1.00 commission from interactive brokers and generally trading right at NAV, it's hard for a mutual fund to beat that, imo.

Certainly someone is getting paid off of ETFs as well, which isn't an issue for me. Like I said, people have to get paid if you want a service from them, that's part of life. I wouldn't begrudge the mutual fund companies their cut, it's just a different type of service at a different price.

[Slava]

Originally Posted by fotze

Because their advisors/experts who also happen to be paid from those MER's told them too?

I read somewhere (here maybe?) that something like 95% of all mutual funds do not beat the indexes. Thats what you are paying the MER fees for, excellence.

Mutual Funds are like th Calgary Flames of the financial world.

I think that 95% is way exaggerated, but I can tell you one thing: 100% of index funds don't beat the market.

[macker]

Originally Posted by Slava

Well thats not the entire story. The MER is higher for sure, but there are no transactional costs for a mutual fund and that is a big difference. There is an option for an ETF that doesn't cost transaction fees now, but its the extreme minority.

There are a few other factors, but when you get really sector specific the other issue is liquidity. A lot of ETFs simply aren't very liquid as compared to a mutual fund.

Another reason is that the mutual funds are actively managed whereas the ETFs (by and large) are not. As the fund buys and sells holdings the fees to operate increase and voila you have a higher MER. The ETF doesn't operate like that though and as such management fees are much smaller.

Actually ETFs have greater liquidity than Mutual funds and this is why they are used so extensively by instutional investors to quickly enter and exit positions and they can be traded during market hours in addition to offering more specific and transparent mandates.

The degree of an ETFs liquidity depends on a combination of primary and secondary factors. Primary : the composition of the ETF, the trading volumes of the securities that make up the EFT and Secondary : the trading volume of the ETF itself and the investment environment. Generally large cap ETFs are the most liquid.

Being aware of how these factors affect an ETFs liquidity, and therefore its profitability, will improve results, which is especially important in investment environments like what we are seeing today where every basis point counts.



Also regarding active ETFs
http://www.bloomberg.com/news/2012-0...investors.html
Gross who manages the worlds largest mutual fund is getting "more active" in ETFs similar to the Horizons Alpha Pro approach but PIMCO would be much more liquid!

Even the father of indexing, Burton Malkiel, can't resist investing some of his money in actively managed mutual funds and individual stocks. It shouldn't be an all or nothing but what works best and adapt your portfolio based on that. Anytime you can get a very broad-based ETF with an expense ratio of close to 0 it is hard to beat and 75-80% of active fund managers can't/won't beat.....

[GP_Matt]

One of the problems with ETF's is that you have to pay a fee to buy into them and pay it each time you up your amount. ie if you are contributing $100 to your account each month and want to increase your ETF holding the fees would wipe out any savings from the lower MER very quickly. When you are holding mutual funds you can generally setup automated transfers and automatic purchases of small amounts every month.
There is also an issue with dividends. Say you take $10000 and buy an EFT that pays 5% dividend quarterly. That puts $125 into your account every 3 months that you have to pay tax on. Unless you plan to contribute another large lump sum every quarter then that money just sits in the account until you do. With a mutual fund the money is automatically reinvested so the money you earn is now earning more money for you.

[Slava]

Originally Posted by macker

Actually ETFs have greater liquidity than Mutual funds and this is why they are used so extensively by instutional investors to quickly enter and exit positions and they can be traded during market hours in addition to offering more specific and transparent mandates.

The degree of an ETFs liquidity depends on a combination of primary and secondary factors. Primary : the composition of the ETF, the trading volumes of the securities that make up the EFT and Secondary : the trading volume of the ETF itself and the investment environment. Generally large cap ETFs are the most liquid.

Being aware of how these factors affect an ETFs liquidity, and therefore its profitability, will improve results, which is especially important in investment environments like what we are seeing today where every basis point counts.



Also regarding active ETFs
http://www.bloomberg.com/news/2012-0...investors.html
Gross who manages the worlds largest mutual fund is getting "more active" in ETFs similar to the Horizons Alpha Pro approach but PIMCO would be much more liquid!

Even the father of indexing, Burton Malkiel, can't resist investing some of his money in actively managed mutual funds and individual stocks. It shouldn't be an all or nothing but what works best and adapt your portfolio based on that. Anytime you can get a very broad-based ETF with an expense ratio of close to 0 it is hard to beat and 75-80% of active fund managers can't/won't beat.....

The liquidity really depends on the ETF though. There are a lot of smaller sector and specialized ETFs that aren't very liquid, and the reality is that this is where investment funds are most useful. Anyone can match the output of a Canadian Large Cap fund, but when you get to some specialized sectors where there are tiny little companies its very difficult without specialized knowledge and coverage.

[macker]

http://www.fundlibrary.com/funds/lis...e=preset&id=AB

http://www2.morningstar.ca/homepage/...?culture=en-CA


Above are both good sites for taking out the garbage......

[macker]

Originally Posted by GP_Matt

One of the problems with ETF's is that you have to pay a fee to buy into them and pay it each time you up your amount. ie if you are contributing $100 to your account each month and want to increase your ETF holding the fees would wipe out any savings from the lower MER very quickly. When you are holding mutual funds you can generally setup automated transfers and automatic purchases of small amounts every month.
There is also an issue with dividends. Say you take $10000 and buy an EFT that pays 5% dividend quarterly. That puts $125 into your account every 3 months that you have to pay tax on. Unless you plan to contribute another large lump sum every quarter then that money just sits in the account until you do. With a mutual fund the money is automatically reinvested so the money you earn is now earning more money for you.

This is something you should be able to work out with your discount broker. You shouldn't be paying fees in this manner

[TorqueDog]

Oh how I hate mutual funds.

[GP_Matt]

I use a full service fee only broker. Some of my investments have to be run through a full service broker, or at least life is much easier if they are.