‘I feel like my bank mutual funds are a dirty little secret’

A question to ponder for all those who care about investors making good decisions: Would the world be better or worse off without bank mutual funds?

I say worse. While there are almost always better choices than bank mutual funds, they are better than not investing at all. And, let’s be honest, some people will achieve all the financial success they need with bank funds. A reminder of this reality came recently through a note from a reader of the Carrick on Money newsletter.

This person said they have always held bank mutual funds in their registered retirement savings plan and tax-free savings accounts, and are happy with the returns. But at the same time, personal finance experts seem to be against bank funds and in favour of replacing them with exchange-traded funds.

This reader feels like their mutual funds “are a dirty little secret.” Are mutual funds really that bad, this person asked.

There’s an awful lot of money invested in bank mutual funds with high fees that help keep their returns below what comparable ETFs could deliver. ETFs are traded like stocks, which means you may have to pay a brokerage commission to buy and sell them. But the cost of owning ETFs is much less than mutual funds. That, in brief, is why personal finance people like ETFs over mutual funds.

Bank funds come in for particular vitriol because they are relentlessly pushed on unsophisticated investors willing to buy what banks are selling in their branches and, sometimes, through their in-branch planning staff. Bank funds dominate the fund industry for no good reason beyond the ubiquity of branch networks. The dominance is not earned through performance.

Still, bank funds have a role. They cost nothing to buy, they can accommodate purchases as low as $50 to $100, they automatically reinvest dividends at no cost and they’re available in a retail format. Really, what are bank branches these days but financial stores with a sideline in helping customers with basic banking transactions?

It’s a complete misreading of investors to expect that if we educate them enough, they’ll all move out of bank funds and into ETFs. Lots have made this migration, and many more will do so in the years ahead. But for the foreseeable future, there will be a demographic that feels happiest when their financial needs are met by their bank. The best way to fight bank mutual funds might be to develop a competing model of multi-faceted financial services that includes lower-cost investing. This is what Wealthsimple is doing – anyone else?

A thought for the reader feeling mutual fund shame: Benchmark your funds against comparable ETFs. Compare your Canadian equity mutual fund return against an ETF tracking the S&P/TSX composite index; U.S. equity funds should be compared to S&P 500 ETFs, and international equity funds against ETFs invested in the MSCI EAFE index or similar.

An important thing to understand about investing is that you don’t need the best outcome – you just need to reach your financial goals, i.e. a comfortable retirement. It’s no doubt easier to do this with ETFs, but bank mutual funds can conceivably get you there as well.