Index funds vs. mutual funds: Which are better?

Mutual funds are a popular choice for Canadians, especially for investors just starting to build their portfolios.  They are easy to set-up at your local bank, and with as little as $25 or $50 a month you can open a pre-authorized purchase plan to get started.

It’s been widely reported that mutual fund fees in Canada are the highest in the world.  According to this recent study by Morningstar, Canadian mutual funds have notoriously high management expense ratios.  The typical investor in a Canadian equity fund pays a management expense ratio of between two and two-and-a-half per cent.

I looked at the basic Canadian equity mutual funds offered by each of the five big banks and prepared a table that compares the 10-year performance of these mutual funds to their low-cost index fund equivalent. 

Investors have been led to believe that paying higher fees will result in superior returns.  The table suggests that is not the case. 

For decades, low cost index funds, and more recently low cost index ETFs have provided higher returns when adjusted for investment risk.  Market indexes will outperform 80 per cent of actively managed funds over the long term.

Mutual funds are still a great place for investors to start, but investors need to do a better job understanding the fees they are paying. 

You don’t have to settle for the expensive growth fund recommendations offered by your financial advisor.  Ask questions, shop around for cheaper index funds, or look into ETF’s as a low-cost alternative.  Don’t let your portfolio get eaten away by unnecessary fees.  

Also Read:

How index funds can help boost returns

5 simple steps to improve your finances

Robb Engen is half of the Boomer & Echo personal finance blogging team with his mother, a former financial advisor.  Reach him at robbengen@gmail.com