The Long term Costs of Picking Mutual Funds over ETFs

Picking a mutual fund with a 2.2% MER that has the same stocks as an exchange traded fund with a 0.06% MER can reduce your portfolio balance after thirty years by as much as 48%.
    Many mutual funds have a MER that is higher than the dividend yield.  Really think about that.  You are taking all the risk and the mutual fund company is collecting a fee that is equal if not higher than your dividends.  If some snake oil salesman came to your grandparents door and said he would invest their portfolio and take all the dividends for himself, you would be calling the cops.
    If the mutual fund held the same stocks as the Vanguard Canada ETF then your balance would have 35% and 48% less after 20 and 30 years respectively.  The cumulative costs sound unbelievable, that is why we put the math behind the numbers for you.


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Credit Card Nerd Math

2.2% MER doesn't sound like much, but it adds up quickly.  Let us show you how quickly, but first we will take off 0.55%, which is a typical rate for some of the more specialized ETFs such as the XDV by iShares.  2.2% - 0.55% = 1.65% extra expenses.
    If both funds own the same stocks, then the investor that bought the mutual fund instead of the ETF should have a balance that is 8%, 15%, 22%, 28%, 34% and 39% less after 5, 10, 15, 20, 25 and 30 years respectively.  If the mutual fund held the same stocks as the FTSE Canada Index by Vanguard Canada (VCE) then it would have 19%, 35% and 48% less after 10, 20 and 30 years respectively.
    The numbers work like this.
Mutual Fund vs XDV difference over five years 0.9835%5 = 92% or 8% less.
Mutual Fund vs XDV difference over ten years 0.9835%10 = 85% or 15% less.
Mutual Fund vs XDV difference over fifteen years 0.9835%15 = 78% or 22% less.
Mutual Fund vs XDV difference over twenty years 0.9835%20 = 72% or 28% less.
Mutual Fund vs XDV difference over twenty-five years 0.9835%25 = 66% or 34% less.
Mutual Fund vs XDV difference over thirty years 0.9835%30 = 61% or 39% less.
Mutual Fund vs VCE difference over ten years 0.9786%10 = 81% or 19% less.
Mutual Fund vs VCE difference over twenty years 0.9786%20 = 65% or 35% less.
Mutual Fund vs VCE difference over thirty years 0.9786%30 = 52% or 48% less.
    Important Note: Your return will not be decreased by that number, your overall balance will be and it doesn't matter if the funds average 1%, 5% or 20% annually.  The percentage difference will be the same.  Don't believe me, open up an Excel spreadsheet and run the numbers yourself.
    Below we have a chart with a portfolio that shows the annual gain, the balance on a mutual fund with a 2.2% MER and the balance on a ETF such as the XDV with a 0.55% MER.  There are ETFs with a lower MER, but we wanted this to be a relatively fair comparison.  In case you are curious the balance if there were no expenses would be $16,830, $38,049, $77,735, $160,196 and $462,220 after 10, 20, 30, 40 and 55 years respectively.



The Annual Balance on a $10,000 Initial Investment

Mutual Fund vs ETF Portfolio

Year

Return

Mutual Fund Balance

ETF Balance

1

7%

$10,464

$10,641

2

17%

$11,974

$12,382

3

-17%

$9,719

$10,220

4

8%

$10,267

$10,977

5

-5%

$9539

$10,371

6

29%

$12,034

$13,305

7

-2%

$11,534

$12,967

8

11%

$12,521

$14,314

9

25%

$15,307

$17,795

10

-10%

$13,473

$15,927

15

8%

$17,713

$22,766

20

9%

$24,385

$34,075

25

3%

$25,292

$38,427

30

12%

$39,882

$65,881

35

8%

$54,432

$94,167

40

7%

$65,797

$128,482

45

8%

$86,501

$183,648

50

5%

$98,778

$228,011

55

9%

$135,984

$341,281


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A Wake Up Call

The numbers are real and if you can prove me wrong, then let us know.  We even went with the XDV for comparison so that you can see that even a modest improvement in your portfolio expenses can go a long way.
    One of the more important points to remember is that MER is an expense on your balance and does not necessary reflect on the risks and/or performance of a particular fund.
    Important Note: This is not a article on selecting what to put in your own portfolio, but merely an illustration on the cumulative long term effects of MER between two different products and there is no guarantee that an ETF will outperform a particular mutual fund.