Active fund manager Warren Buffett has given an endorsement of index investing on more than one occasion. The fact is, even really savvy hedge fund managers have trouble outperforming a low-cost fee ETF. At the end of the day, it comes down to cost. Active management can be expensive, and if the returns aren’t there to warrant it, it’s the little guy taking it on the chin.
Wealthy individuals, pension funds, endowments all feel with money should come expertise and extra investment advice and an active fund manager or advisor will highlight this. However, it also speaks to the old adage: When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.
Based on cost alone, we should all explore investment options. What really matters is not active or passive management, but substance — cost, portfolio turnover, disciplined, information-based strategies. If you buy funds with those characteristics in mind, odds are that you’ll create a portfolio of above-average, higher-quality products costing you less in the long run.
For now, let’s set aside active fund management and look more closely as passive strategies mutual funds and exchange traded funds:
The number of ETFs on the TSX just hit an important milestone – 500. And that number has more than doubled in the past five years and the market capitalization is growing, as of June 30, 2017 it stood at $130B. A big number, sure, but pales in comparison to mutual funds which still dominate the investment landscape at $1.41 trillion dollars under management. Of course they have been around for a much longer period of time.
Which though would be better for your portfolio? “There really is no single answer,” explains Anthony Boright, president ar InvestorCOM Inc. “Yes, mutual funds tend to have higher fees than ETFs, but they also include more portfolio management and service. It really comes down to what it is the individual wants, how they want to achieve it and how much they are willing to spend to reach their goals.”
By the way, InvestorCOM creates and delivers funds facts documents for mutual funds and ETF facts for investors of ETFs in Canada. It also provides their clients with the technology to create investment statements regarding performance and fees and to deliver them digitally or through traditional print/mail channels.
ETFs have a lot in common with mutual funds. Both offer shares in a pool of investments designed to pursue a specific investment goal. And both manage costs and may offer some degree of diversification, depending on their investment objective.
Important differences to highlight:
- Mutual funds accumulate a collection of stocks, bonds, and other securities managed and shaped by financial professionals.
- ETFs are linked to a particular index and use a passive and hands-off approach that reduces overhead and fees.
- Mutual funds trade only at the end of the day.
- ETFs trade throughout the day on a stock exchange like a stock.
But at the end of the day, the active vs. passive debate is flawed. You can be very active using index funds and very passive using active funds. I believe the point Warren Buffet was making is this: the real comparison should be low-cost vs. high-cost, low-turnover vs. high.