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Should you switch from mutual funds to ETFs? Here's what the experts say

Bank towers are shown from Bay Street in Toronto's financial district, on Wednesday, June 16, 2010. Provincial securities regulators across the country are moving to ban the sale of mutual funds that pay upfront commissions to financial advisers and charge clients early withdrawal fees, with one notable exception. THE CANADIAN PRESS/Adrien Veczan
Mutual funds have come under scrutiny of late because of their high costs relative to newer alternatives, such as exchange-traded funds. (THE CANADIAN PRESS/Adrien Veczan) (The Canadian Press)

Mutual funds have long been a popular investment vehicle for Canadians. And for good reason, says Stephanie O’Mahoney, head of operations and portfolio management at Super Advisor.

“Mutual funds were an amazing revolution in the personal finance space because they allowed regular people to buy the stock market,” O’Mahoney told Yahoo Finance Canada.

Previously, investors needed to work with a broker to buy individual stocks, and it wasn’t cheap, O’Mahoney notes. Mutual funds allow investors to pool their money together to access a collection of stocks and other assets, all managed by a professional fund manager.


“So, when they came to Canada, it was a net win for people,” O’Mahoney said.

But they’ve come under scrutiny of late because of their high costs relative to newer alternatives, such as exchange-traded funds (ETFs), O’Mahoney says. Canada’s mutual fund fees are also among the highest in the world, according to Morningstar.

And yet, Canadians still have more than $2 trillion in mutual fund assets, according to data released last month by the Investment Funds Institute of Canada (IFIC). O’Mahoney questions if this is still the “most useful and cost-effective way” for Canadians to invest their money.

“At this point, I don’t think it is anymore for your broad portfolio,” she said.

To get a better understanding of the mutual fund you’re invested in, O’Mahoney suggests looking at two key indicators: the Management Expense Ratio (MER) and the growth of the fund compared to an index. Both are displayed on your fund’s Morningstar page, which can be found with a quick search, she notes.

“The reason I call out MERs is because finance is one of those few industries where we have what’s called embedded fees,” O’Mahoney said. “So, the client isn’t getting a statement of how much they’re paying for this investment. It’s coming off their return.”

When a fund reports its return, the fees have already been deducted. There’s no additional calculation required. But mutual fund returns often lag the market by about their MER, O’Mahoney notes, which is why she says it’s important to compare the fund’s growth compared to the market as a whole, or the index.

Over the last 10 years, only 3.37 per cent of actively managed Canadian equity funds outperformed the benchmark S&P/TSX Composite Index, according to S&P Indices versus Active (SPIVA) research. And as for those funds that did achieve top-quartile performance, SPIVA found no evidence of persistent outperformance over a five-year period.

“The only part of persistence that does exist is that the bad ones stay bad,” Cameron Smith, wealth advisor at the Investment Planning Counsel, told Yahoo Finance Canada. “Aside from that, it’s relatively random. So, at what point do you just say, ‘If you can’t beat it, join it?’”

Smith and O’Mahoney agree that a low-cost passive investing strategy that seeks to track the index will be the right approach for most Canadians. This is a big part of the reason why ETFs continue to grow in popularity.

So far in 2024, net sales of Canadian ETFs are $12.63 billion, compared to $2.65 billion in mutual fund net sales, according to the latest IFIC data.

“ETFs are the best option as an alternative to mutual funds in Canada,” O’Mahoney said, highlighting their ability to track global markets at a low cost.

If a client feels passionately about trying to get an alternative type of exposure in their portfolio, perhaps away from ultra-high cap tech stocks to more small-cap companies, O’Mahoney says there might be a case to be made for paying more for certain mutual funds. Even then, she generally recommends allocating no more than five to 10 per cent of a portfolio to them.

“The number one determinant of long-term returns really is the amount of fees you charge,” Smith said. “So, a mutual fund that is charging 1 or 1.15 per cent per year versus an ETF that’s 0.2 per cent, that’s a big amount of money.”

Smith says it's important to understand what type of mutual funds and ETFs you are invested in. Although it’s not the norm, ETFs can be actively managed, and mutual funds can be passively managed. What really matters is their underlying holdings and the fees they charge.

Despite all the discussion around fees, O’Mahoney stresses the importance of obtaining professional financial advice, because most people will require more support to achieve their goals than simply reducing their investment costs.

And the advice should go beyond picking investments. A good advisor can add up to three per cent in net returns through tailored wealth management and financial planning strategies, according to Vanguard, “rather than by trying to outperform the market.”

If you own a Series A mutual fund, you’re already paying for this advice through the MER, O’Mahoney notes. But she says a lot of people “aren’t getting that personalized experience.”

“Whereas a Series F fund doesn’t bake in the cost of advice,” O’Mahoney added. “So, you’ll get a cheaper fund, but you have to get your advice elsewhere.”

Regardless of how you choose to invest, by not getting advice, she says “you’re going to be exposing yourself to a lot of risk either way.”

Farhan Devji is a freelance journalist and published author based in Vancouver. You can follow him on Twitter @farhandevji.