Dale Jackson

Personal Finance Columnist, Payback Time

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Investors who have had it with high mutual fund fees and below-market returns continue to flock to exchange-traded funds.

It’s been happening since ETFs were introduced in the 1990s, but according to Mark Yamada at PUR Investing, in the past two years alone, the amount of money flowing into U.S. ETFs is up nearly 30 per cent.

But whether to invest in a mutual fund or an ETF depends on who you are and how you invest. Here are a few basic pros and cons.   

Mutual funds

Mutual funds are actively managed. That means a professional portfolio manager can implement a strategy to find the best opportunities and manage risk to minimize losses when markets tank.   

Fees on mutual funds in Canada are high by global standards. A typical annual fee, also known as a management expense ratio, can be 2.5 per cent. That’s $2,500 each year on a $100,000 investment. About one per cent of that fee is often returned to the person who sold you the fund for ongoing advice in the form of a trailer fee. Some mutual funds have additional fees including once-time loads based on a percentage of the amount invested when they are bought or sold.

Those fees eat into returns, which helps explain why the average mutual fund underperforms its benchmark index. It’s important to keep in mind that many mutual funds consistently outperform their benchmark indices even after fees, and that’s why you should do your homework and find a manager with a good track record. There are many.

Mutual funds are popular with retail investors because it’s easy to make small regular contributions. Many investors have their contributions automatically deducted each payday. It’s a good strategy to average out the cost so you buy more units when the price of the fund is down, and fewer when the price is up. 

Exchange-traded funds

ETFs are passively managed. That means they are exposed to the whims of the broader market and have no strategy in place to pick the best stocks or manage risk when markets tank.

Fees for ETFs are a fraction of mutual fund fees – usually under half of a per cent each year. The only other cost is a trading fee to buy or sell, which could get pricey for small amounts.

Unlike a mutual fund, which is priced at the end of each trading day, an ETF trades throughout the day like a stock. You know the price of an ETF minute by minute.

ETFs are very transparent. Since they track an index, you know which stocks an ETF holds, their weighting in the index, and how much they are worth on the open market (minus the fee). In comparison, prices and holdings in mutual funds do not need to be fully disclosed or disclosed as often as an ETF.