Mutual Funds: Hidden Costs Matter

Why understanding hidden mutual fund fees is important. Should you consider moving to Exchange Traded Funds? What’s the impact?

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OTA Photos - Analyzing Stock Market

For a while now, I’ve been considering switching from TD Bank’s E-Series index mutual funds in Canada, to lower cost index ETFs. When you’re starting out, TD E-Series funds are great and admittedly, less daunting than dealing with ETFs. They provide a painless way to get your money working for you. As your portfolio grows in value though, it may be worth considering what you’re paying.

I definitely suggest considering the e-series funds for early Canadian investors, for the following reasons:

1) No fee to buy or sell in a TD Mutual Fund / TD Direct Investing account

2) You can set-up an automatic monthly purchase plan, automating adding money to your investments, at no additional cost.

3) They’re some of the lowest cost bank provided index mutual funds in Canada. Tangerine, for instance, has an average MER of about 1.07%. My TD E-Series portfolio was averaging somewhere between 0.42% and 0.45% in fees, based on my allocation.

4) Buying and selling through TD’s platforms (be it TD EasyWeb or TD WebBroker) is extremely simple. You tell it how much of a fund you want it to buy, and off you go.

5) You don’t have to worry about market trading hours. It’s much easier than directly using the stock market to make a purchase. You place a dollar value order and away you go. The order is taken care of after market hours (time to post the transaction and the like is another matter).

ETFs on the other hand, are more complex to buy and sell, and unless you’re on Questrade, will likely have a transaction cost of about $10 each time you buy or sell. ETFs are traded during stock market hours. You’ll generally want to buy them when the stock market is actually open to avoid unexpected price surprises. Mutual fund transactions, by contrast, are processed at the end of the business day, which makes buying and selling a little easier. Further, with ETFs you have to consider the current bid-ask spread, and figure out how to price your order. Not complicated, really, however with mutual funds, you can just enter a total dollar amount you want to buy, and you’re off to the races.

With that said, as your portfolio grows in value, ETFs can provide a notable fee savings, through their lower Management Expense Ratios (MER). Factor in advisor fees, and the cost difference grows even larger.

A Cost Comparison between TD E-Series Funds and Vanguard ETFs

Let’s do a quick Comparison, comparting TD’s fund expenses to Vanguard Canada’s, to give you a better idea of what a regular investor might be paying.

TD E-Series Fund MER

TDB900 (Canada) TDB902 (U.S.) TDB911 (International) TDB909 (Canadian Bond)
0.33% 0.35% 0.51% 0.50%

Vanguard Canada Fund MER

VCN(Canada) VXC (International including U.S.) VAB (Canadian Bond)
0.06% 0.27% 0.13%

Note: Vanguard’s VXC covers U.S. and international markets all in one fund, which accounts for the difference in number of funds.

Given these percentages will look small to most, being a fraction of a percent, let’s do some math. Assume Bob has $100,000 dollars invested in each of these portfolios. For TD, we’ll go with a simple 25/25/25/25 asset allocation split equally across their four funds. In Vanguard’s case, we’ll go with a 33/33/33 split for their funds. Let’s see what the annual cost difference looks like.

Bob’s TD E-Series Annual Cost Breakdown:

Fund Value MER Cost
TDB900 $25,000 0.33% $82.50
TDB902 $25,000 0.35% $87.50
TDB911 $25,000 0.51% $127.50
TDB909 $25,000 0.50% $125.00

Bob’s Total Annual Cost with TD: 82.5+87.5+127.5+125= $422.50

Bob’s Vanguard Canada Annual Cost Breakdown:

Fund Value MER Cost
VCN $33,000 0.06% $19.80
VXC $33,000 0.27% $89.10
VAB $33,000 0.13% $42.90

Bob’s Total Annual Cost with Vanguard: 15+40+67.5+32.5 = $151.80

Bob will pay an additional $270.70 yearly, on a portfolio of $100,000 with TD’s E-series when compared to Vanguard. If you consider the power of compounding amounts in your investments, you should also be aware of the power that compounding costs can have to eat away at your retirement money.

I would wager many investors don’t quite consider the impact these costs can have on your ability to retire comfortably. Over a lifetime, these annual costs can account for tens of thousands of dollars that you might otherwise have available in your accounts. The cost gulf between quality index ETFs and mutual funds grows when you look at actively managed mutual funds, with MERs between 1.6% and 2.6% on average in Canada. Are you getting value for you you’re paying for, or are you ensuring bank advisors/brokers have a great vacation, fueled by your retirement savings?

Summary

TD E-Series funds, or even ETFs, are not for everyone. There are other options available like Tangerine or Robo-advisors, where you transfer money, and they handle portfolio asset allocation in low cost funds. The key take away from all this, is ultimately that costs matter. There’s no requirement for firms to show you what exactly you’re paying holistically, even with the new CRM2 regulations in force in Canada. The regulations will show what you’re paying for investment advice, but not so much what you’re paying for your actual investments. Costs matter, and if you don’t take charge of what you’re paying, nobody will.

Resources

  • Canadian Couch Potato on whether moving to ETFs makes sense.
  • Morningstar has a two part series on what Canadians pay for mutual funds, if you want to learn about different types of costs. Part one and part two are linked.
  • Steadyhand has a relevant article explaining investment costs, including a useful infographic.
  • Vanguard has a great write-up on the differences between mutual funds and ETFs.
  • Bonus image, by Sacha Schua (CC by 2.0) which spoke to me, when learning about ETFs (I found my first experience buying ETFs more stressful than I anticipated):

Sacha Schua - Thinking about my ETF hangups -- index card

Header image by OTA Photos – Analyzing Stock Market // CC by 2.0