Exchange Traded Funds vs. Mutual Funds: The Value of Advice
What’s so appealing about Exchange Traded Funds (ETFs)? They can offer annual fees of less than 1%! After all, why pay more when you can invest at almost zero cost?
But is it true that ETF are less expensive?
Many marvel that ETFs, which reproduce indices like the S&P 500, have management fees as low as 0.10%. However, consumers should look past this low number and consider “hidden fees.”
Firstly, an ETF always moves away from the index it reproduces over time, which translates to a loss of return. This loss can be modest in a broadly-focused ETF, but adds up for specialized funds, as shown in a study by Dan Hallett, where the funds under observation were more than 60% behind the benchmark after two years.
To counter (or minimise) the move away from the index, the manager must buy and sell shares to continue to mimic the benchmark as closely as possible. These transactions incur commission and have a tax impact, paid out of the fund’s returns. At the end of the year, this can translate to 1-2% lower returns.
Finally, when calculating the “hidden fees” of an ETF, a savvy consumer will consider that the management expense ratio of an ETF is similar to that of a mutual fund. The difference is that mutual funds offer active management. Teams of analysts and fund managers employed by mutual funds have the sole objective of maximizing the return on your investment.
Mutual funds normally also include a trailer fee paid to the advisor. This means that in addition to the teams managing your mutual funds, your advisor is also there to revise and adjust your portfolio to take full advantage of changing investment opportunities in the markets.
Low fees or high returns, that is the question!
In the end, you should ask what is more important to you: lower fees, or a higher net return? We all want more money in our pockets, so why not choose the option that lets you maximize your investment?
What are the questions to ask yourself when thinking about your money? First, does your advisor add value to your portfolio by adjusting and revising it over time? Second, is your money strategically invested, or simply placed in a “catch-all” fund that offers an average return?
If your current advisor isn’t bringing you added value, why pay him commission? You might as well opt for an ETF – or find an advisor who’ll really work for you!