Got Mutual Funds? - 4 Questions You Should Be Asking
1. What Mutual Funds Do I Own and Why?
I'm always amazed when I discuss the topic of investing with someone and they have little to no knowledge of what they own. "I own a bunch of mutual funds. All low risk stuff." they say to me. There is a funny misconception that all mutual funds are "low risk". I'm pretty sure this idea of safety comes from the way they are sold and who's selling them.
Canadians trust the banking system like no other nation and many have been with the same institution for their entire lives. So, if an employee at your bank is telling you to invest your excess savings into mutual funds it must be the right thing to do. Or is it? Don't forget that banks bring in billions of dollars a year in fees. The financial institutions who sell mutual funds are in the business of earning fees and so is the person recommending them to you.
I've also found that most people have little or no idea what they own and why they own it. The most common answer is that it's a "long term" investment and very "low risk". In my opinion it's risky to have very little knowledge of what you own and why.
If you own mutual funds you at least owe it to your hard earned money to find out what type of fund it is, what sectors or individual stocks it owns and how much it charges in fees.
2. What Do I Pay In Fees?
Fees? What fees? Yes, I've heard this before. Some people actually believe that investing in mutual funds is free! Okay, the majority of us know there are always fees. But I can tell you that an overwhelming number of people have very little knowledge of how much they're actually paying.
The fees are there and are being collected but for years they have been hidden or at least not very easy to find. This is suppose to change by July 15, 2016 under CRM 2 (Client Relationship Model Phase 2). Your fees will be a lot easier to understand and more clearly stated. One such change is the dealer or adviser compensation must be shown in dollars for the products and services provided.
The fees are not changing but the way they are disclosed are. This could cause some sticker shock for those who feel the compensation hasn't been worth the performance or service received.
When your investment professional recommends a product keep in mind that he/she might be recommending something that pays them the highest fee. If the products are similar, which a lot of mutual funds are, they may be more inclined to suggest the higher fee product. It's human nature to want to earn as much as we can. After all, we all have bills to pay.
According to this short piece on BNN (Hidden investment fees to be revealed) the average MER (Management Expense Ratio) of the typical mutual fund is around 2.5%. Out of this 2.5% your financial planner or the person who sold you the product takes home around 1% usually called a trailer fee. There may also be other fees on top of this 2.5% such as administration fees or a "load fee".
3. What Do I Get For The Fees I Pay?
This is not the easiest question to answer but it needs to be addressed and it can only be answered by you. Lets take a look at what the person selling you the mutual fund receives in compensation in most situations (the below doesn't include the 1.5% that goes to the mutual fund dealer on average):
- $50,000 Invested - You pay $500 to the person who sold you the fund
- $100,000 Invested - You pay $1000
- $500,000 Invested - You pay $5000
You get the idea. It's simple math. What are you getting for this fee? Is it making you more knowledgeable or educated about investing and the markets? Are you getting market returns after fees? How much time, effort and research is involved for the person choosing a fund for you? How many clients do they have and how much of their time do you get?
4. What Options Do I Have?
You have a lot of options when it comes to how you invest your money. From mutual funds at the bank, a full service investment adviser, portfolio manager, Fee-Only Adviser, Robo Adviser, or DIY investing.
If you are paying someone to manage your money at least make sure you know how much you are paying so you can decide if it's worth it. If you're going at it alone then you'll need to take the time to learn more about the markets and what products are available to you, such as individual stocks and low cost exchange traded funds.
Whatever you choose remember that no one cares more about your money then you do. It's up to you to educate yourself on what's available to you and at what cost.