If you invest for retirement, you probably do it through mutual funds.
As of 2025, Canadians had $2.8 trillion socked away in mutual funds, according the Investment Funds Institute of Canada (IFIC).
If you have a defined contribution pension at work, it’s probably a portfolio of mutual funds. And they are likely the first thing your bank recommends when you contribute to your registered retirement savings plan (RRSP).
Why not? They are the only way for average investors to hire professional managers to buy the best companies while hedging risk through diversification.
But the cost of that service is drawn from annual returns - typically around 2.5 per cent of the total amount invested - to pay for that management, millions of dollars in marketing every RRSP season, and even that bank employee who recommended it.
A lower-cost alternative that can still provide diversification, without active management is index-linked exchange traded funds (ETFs).
Whether to hold mutual funds, ETFs, or a mix of both depends on your investment objectives. Here are a few things to keep in mind:
The case for mutual funds
The thousands of mutual funds available on the market focus on just about every sector, subsector, geographic region or investment style imaginable.
Professional, active, managers normally have access to the best research and can pick and choose individual holdings and their weightings within the fund.
Professional investing requires a great deal of education and experience to be successful. It also requires a hard-to-quantify ability to identify and manage risk; especially near or in retirement when the stakes are so high.
Active managers are trained to identify a company’s earning potential along with potential risks by pouring through quarterly corporate earnings statements, and often establishing direct relationships with management.
They can assess the broader sector, market, and economy on a macro level and determine if the company’s earnings justify its current price levels.
The downside of mutual funds
There is a cost for professional management in the form of fees. Canada is notorious among developed nations for high mutual fund fees.
Fees, expressed as the management expense ratio (MER) or a percentage of the amount invested, can top 2.5 per cent annually. Within that MER, an annual commission called a trailer fee could be awarded to the advisor who originally sold the fund.
Performance data over several time periods shows the average Canadian mutual fund underperforms its benchmark index once fees are taken into consideration, leaving less money invested to grow over time.
Many mutual funds consistently beat their benchmarks even after fees, but limited disclosure requirements make it difficult for average investors to find the best ones.
That lack of transparency opens the door to what is called “shadow indexing”, where actively-managed portfolios bear a striking resemblance to their benchmark indices. Investors are basically paying for active management and getting a passive index fund.
ETFs allow you to buy the benchmarks
With index-linked ETFs, the entire market is your manager.
In its purest form, passive management attempts to replicate broader indices by tracking individual holdings based on their weighting in the index and adjusting them daily as they change in value. No arbitrary decisions are made. They set it and forget it.
Unlike mutual funds, holdings and their weightings in index-linked ETFs are transparent. Price changes in S&P 500 ETFs, for example, will reflect price changes in the actual S&P 500.
ETFs can also provide access to a diversified array of sectors and geographic regions at a fraction of the cost. The MER on basic index-linked ETFs that track major indices could be as low as one-tenth of a per cent.
The downside of index-linked ETFs
While major stock market indices have always gone up over time, the market is not so good at anticipating shorter-term volatility.
ETFs have no active manager to assess and steer clear of riskier holdings in an index or determine when it’s time to sell over-valued holdings and take profits.
The success of ETFs has also moved providers to blur the line between passive and active management through “hybrid” or “smart” ETFs that apply arbitrary formulas.
As ETFs become more elaborate, fees tend to rise.
