Why You Might Still Want to Buy Mutual Funds from Banks
Bank reputations are “in the toilet”
The recent CBC Marketplace story on the sales culture inside the banks has proven to be a cautionary tale when it comes to using the banks for transacting in your financial business. As for the topic of this blog post, buying mutual funds, the licensed mutual fund sales reps were either misinformed or misleading their customers. A particular example of this was the incorrect explanation that “mutual fund fees are only charged on the profit the investment earns, not the entire lump sum.”
Mutual Fund Fees
Mutual fund fees, properly referred to as the Management Expense Ratio or MER, are a percentage of the value of the mutual fund. Every mutual fund or Exchange-Traded Fund (ETF), for that matter, charges an MER. For example, if you have $10,000 invested in a mutual fund and it grows by 10% or $1,000 that year, you will not have $11,000. Instead, you will have $11,000 minus the MER. If the MER is 2%, you will have approximately $10,780. The difference between $11,000 and $10,780 is $220, which is 2% of $11,000. That reduces the gain you receive from 10% to 7.8%. That 2% fee applies regardless of the performance of the fund, by the way. So, if one year later, your $10,780 investment in your mutual fund stays flat, you will have been charged $215.60 ($10,780 x 2%) and your new balance will be $10,564.40.
Before I proceed, I need to point out that the paragraph above is a bit simplistic in that there is no deduction at the end of the year on the entire value of the mutual fund in question. Instead, throughout the year, the mutual fund’s price or Net Asset Value (NAV) has already taken the MER into account. In other words, you never see the full cost of the mutual fund, although your end-of-year statement should indicate any commissions paid to the advisor by the fund company.
Mediocre Performance
As I noted above, banks that sell mutual funds to their customers charge MERs. This is not unusual. What tends to be a distinctive fact about bank-owned mutual funds that are distributed through local bank branch channels, is that they tend to have higher-than-average fees and consequently lower-than-average performance. As Morningstar, the investment research firm, confirms, “there is a clear relationship between fees and performance.” You can find lower-fee funds, some that are even available through bank channels, but they are not the funds that are going to be on offer to you, and they might have higher minimum initial purchase limits making them a little bit less accessible.
So, Why Recommend Bank Mutual Funds?
Having said all that, why would I, a financial planner, recommend bank mutual funds? My first response is that I’m not so much recommending bank mutual funds as I am recognizing that a lot of Canadians get their start with the banks, and I think that the worse situation is not to invest at all. Yes, you can set yourself up for much better expected outcomes, but compared to doing nothing at all, starting with a mediocre investment is the better choice. That said, here are my reasons why someone who has never invested beyond a savings account or GICs, might want to step into the world of investing in assets that come with the risk of uncertain returns and even financial losses.
Ease of Access
Although some smaller communities have lost their banks, there are still many cities and towns where you can find multiple banks and credit unions. For the last 23+ years, I have been living in London, Ontario. Within a 15-minute walk of my home, I can find at least one branch of all six of the major banks in Canada as well as one credit union. It is often said that Canadians “love their banks.” While I believe that love is unrequited (that is, the banks don’t love you back), the convenience of going into the bank branch where you do most of your financial business to ask a sales representative to recommend a mutual fund for you should not be underestimated. I think this is especially the case for someone new to investing.
Low Entry Cost
Ease of access is not just about location. An equally, if not more, important factor is the low initial cost to buy most bank mutual funds. The initial minimum for five of the six banks is $500. TD is an outlier in that you only need $100 to invest in their most commonly recommended series of mutual funds. For someone ready to invest but who only has a small surplus of savings, this low entry cost is an important factor.
Customer Service
This is related to the reason above. While the range of investments available is limited to those with that particular bank’s mutual fund division, the fact that you can find someone to do the work for you, walk you through the paperwork, present a recommendation, and arrange for the purchase, while all you need to do is to agree to the purchase and permit a withdrawal from the chequing account that you hold at the very same branch, has a great deal of appeal.
Automatic Investment Plan
A Do-It-Yourself (DIY) investor who buys ETFs or individual stocks and bonds has to make a deliberate choice to invest. Mutual funds are different, however. You can set up an automated or systematic investment plan so that at the same time every month, a specific amount of money is withdrawn from your bank account and automatically invested in the same fund, month after month. As Nick Maggiulli, Chief Operating Officer of Ritholtz Wealth Management, blogger, and author of the book, Just Keep Buying, points out, one of the most important things you can do to build your wealth is to, well, “just keep buying.” Making the buying process automatic makes it that much easier.
Diversification
The whole idea of a mutual fund (to be clear, this includes ETFs, too) is that an investment firm sets up a portfolio or basket of investment assets, stocks and/or bonds, most commonly, that individual investors can buy into, each sharing a small slice of a well-diversified portfolio consisting of dozens, if not hundreds, of individual investments that would be impossible for all but the wealthiest persons in the country to obtain without resorting to some sort of fund structure.
Reputation and Trust
I debated whether to include this point. As I write this, TD, the second-biggest bank in Canada and a major presence along the east coast of the United States, is undergoing a significant hit to its reputation – and stock price – due to accusations of lax procedures to counter money laundering. Nevertheless, the banks in Canada are established institutions that tend to undergird a sense of trust, an encouraging element for beginning investors. Credit unions, often confined to a region of a single province, and provincially regulated, have their own version of trust in that they are owned by their members, so the profits go to the members, not to the anonymous and ever-changing shareholders of the banks.
Examples of the Leading Bank-Issued Balanced Mutual Funds
The classic investment asset allocation consists of 60% equities and 40% fixed income, the so-called 60/40 portfolio. For this section, I looked for 60/40 balanced mutual funds that are available through retail bank branches and have low minimums. The following funds are listed in alphabetical order.
Fund Code
This is a way of identifying the mutual fund. Some funds are available in a variety of series and will have slightly different codes to distinguish them from others. Those distinctions tend to be tied to pricing. For example, these are funds meant to be delivered through a commission-based advisor channel, thus at the end of the name you will see the word Advisor or simply A. The mutual funds from National Bank (NBC924) and Toronto-Dominion Bank (TDB887) use the word Investors or I to distinguish them from the other series. In the case of these types of funds, a portion of the fee (the MER) is remitted from the mutual fund company (often referred to as an Asset Management Company) to the advisor/the advisor’s firm (the bank) in the form of a “trailing commission” meant to compensate the advisor for the ongoing investment advice that is presumed to be part of the advisor’s job.
Many mutual funds are offered in the F series and are offered through a fee-based investment advisor who negotiates the fee with the investor. These typically have significantly lower fees since compensation to the advisor is not provided through a trailing commission from the fund but is rather through the above-noted negotiation. The combined MER and fee are often less than the MER for an A series fund because these types of advisors tend to serve clients with more assets to invest.
Fund Name
This should be straightforward. Ideally, they are descriptive of the type of fund. Using the terminology established by the Canadian Investment Funds Standards Committee (CIFSC), these are all Global Neutral Balanced mutual funds.
AUM in $Billions
These are large mutual funds. AUM refers to Assets Under Management. However, these figures likely refer to all the series of funds that fall under this particular name. My point in listing this column is to show that these are not obscure mutual funds but are among the more popular funds offered by the fund company.
Morningstar Rating
Morningstar assigns a star rating to indicate a particular fund’s past performance. It is purely a numbers system; no qualitative impressions are included in the evaluation. The funds are evaluated within the same category to maintain an “apples-to-apples” comparison. The star system is ranked from 1 to 5, with 1 star being the lowest rating and 5 stars the highest. You will note that except for NWT019, which has a 2-star rating, all the other funds have 3-star ratings, meaning that they have middle-of-the-pack performance. The star rating is only one component of a mutual fund evaluation process; other factors should also be considered.
MER (Management Expense Ratio)
I explained the MER earlier. The main reason for showing this is to help investors recognize that fees are associated with mutual funds. Despite not paying a fee directly to the bank investment advisor, do not think that bank representatives are selling these products at no charge. Note the average of 1.99% across the funds represented.
Initial Minimum
The low minimums to get started with these mutual funds is, I think, one of their most attractive features. You don’t need a lot of money to get started in investing. Other mutual funds may have $2,000, $5,000, or $10,000 minimums, if not higher, which can be challenging for many people who are just starting with investing.
2023 Return
Mutual funds do not trade on the open market. Instead, they are bought and sold between an investor and the mutual fund company. As such, they are priced only once a day after the markets close at 4:00 pm Eastern Time, based on the Net Asset Value (Fund Assets – Fund Liabilities) of the underlying securities held in the mutual fund. Since there are often many millions of mutual fund units that are owned by investors, the price you see for a mutual fund is properly known as the Net Asset Value per Unit (NAVPU). Less commonly, the price may be labelled as the Net Asset Value per Share (NAVPS). The difference is that fund units indicate a trust structure, while fund shares indicate a corporate structure. Often, it is simply referred to as the NAV.
Last year, 2023, was a year for good investment returns following a dismal 2022 so it’s not surprising that most of the funds had double-digit returns.
Comparing Mutual Funds to ETFs
There are very good reasons why an increasing share of investors are investing in ETFs. They have lower fees, which, as I’ve noted before, tends to mean higher net returns. The following is a list of ETFs that target the same 60/40 global neutral balanced strategy.
I will note here that I included GBAL among the other ETFs because the mutual fund from NEI Investments (NWT019) follows a socially responsible investing mandate, which is similar to the ESG criteria used in GBAL. You will also notice that the average MER across these five funds is 0.22%, much lower than the average for the mutual funds. The average 2023 return is also higher for the ETFs than it is for the mutual funds. I offer the table below as a means of comparison.
Using the average mutual fund data as the baseline, you can see that mutual funds are more expensive, and have poorer returns. The MER does not explain it all, however. There is still a discrepancy of 1.82% between the two categories. This can probably be understood as a difference in the underlying assets. Even though the mutual funds have approximately the same allocation as the ETFs, at 60/40, their mandate to engage in the active selection of securities is not helping them. In contrast, the ETFs seek only to track an underlying index.
It should be noted, however, that ETF performance does not consider any commissions that might be charged to purchase these funds. While mutual funds are bought “free of charge,” that is, without a commission charged by a broker, ETFs are subject to commission charges. If you are a DIY investor, an increasing number of brokers will let you purchase ETFs without a fee, but many of the mainstream online brokers, those that are owned by the big banks, for example, will charge up to $9.99 per trade. For this reason, I tend to encourage ETF investors to make sure they have enough money to buy at least $1,000 worth of a given ETF and my preference is to encourage purchases of $3,000 or more to minimize the impact of commission charges. This is effectively a barrier to those getting started with investing, not to mention the complication of having to calculate the number of shares you can buy given the spreads between the bid and the ask prices.
What Should the Would-Be New Investor Do?
Despite the likelihood of higher fees and consequent poorer returns, I am okay with encouraging the new investor to go to a local bank or credit union to open a mutual fund account. Investing may be simple, but it’s not easy; it can be intimidating. This is doubly so when you only have a little money to invest. The psychological barriers can be overwhelming. Getting started at your local branch makes those barriers easier to get through. That doesn’t mean you should stop there, though. Investing at your local branch is your entrée into a greater depth of understanding and can give you the confidence to seek a more efficient and effective path to growing your wealth.
This is the 246th blog post for Russ Writes, first published on 2024-05-06
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions