Thursday, November 23, 2017
Are You Ready to Rumble? – Mutual Funds Versus ETF’s
In the investing world, a battle has emerged between the old school and the new. For decades Canadians, and many other nations, have been using Mutual Funds to get a piece of the market without the risk of stock market investing. Millions have used them to retire comfortably and even get very wealthy in the process. In the early 1990’s a new kid came on the block called the Exchange Traded Funds (ETF), also known as Index Funds. This product was an alternative to mutual fund investing and provided investors with a piece of the entire market as opposed to the pieces selected by a fund manager. ETF’s provided a lower cost solution as they didn’t have the layers of management that mutual funds have. Lately, the investing world has seen the rivalry develop. There have emerged two camps: Active versus Passive management. The two sides have their backers and their detractors, and both passionately state their case. The question remains: What is best for you? In this post, I will explain mutual funds and ETF’s and give the pros and cons of both. Let’s all remember that investing is all about you, the investor, so knowledge is how you determine what is best to invest in.
What is a Mutual Fund?
History:
A Dutch merchant, Adriaan van Ketwich, had the foresight to pool money from a number of subscribers to form an investment trust – the world’s first mutual fund – in 1774. The financial risk to the mainly small investors was spread by diversifying across a number of European countries and the American colonies, where investments were backed by income from plantations, an early version of today’s mortgage-backed securities. Subscription to the closed-end fund, which Van Ketwich called “Eendragt Maakt Magt” (“unity creates strength”), was available to the public until all 2,000 units were purchased. After that, participation in the fund was available only by buying shares from existing shareholders in the open market.
Modern Day:
The first modern-day mutual fund, Massachusetts Investors Trust, was created on March 21, 1924. It was the first mutual fund with an open-end capitalization, allowing for the continuous issue and redemption of shares by the investment company. After just one year, the fund grew to $392,000 in assets from $50,000. The fund went public in 1928 and eventually became known as MFS Investment Management. Four years later, in 1932, the first Canadian fund, Canadian Investment Fund Ltd. (CIF), was established and by 1951 had assets of $51 million. It changed its name to Spectrum United Canadian Investment Fund in November 1996 and to CI Canadian Investment Fund in August 2002.
Why is this Important?
Mutual Funds were created to pool money from investors. It was a revolutionary approach that promoting security in numbers. Mutual Funds have what is called, “Active Management.” What this means is that they have a person, called a fund manager, who choose what comprises the fund (which stocks). This person usually has a team of advisors and researchers looking for up to date information and trends so that the fund is continually performing. This management is not free, however, as fees must get paid. These fees often come out of your investment and are referred to as, “embedded fees.” They can diminish the performance of the fund you are in. Despite this, millions of people have been using mutual funds for decades to retire wealthy. Mutual Funds are truly the powerhouse when it comes to retirement investing.
Weighing the pros and cons of active portfolio management – CNBC
What are Exchange Traded Funds or Index Funds?
History:
The first real attempt at something like an ETF was the launch of Index Participation Shares for the S&P 500 in 1989. Even though there was quite a bit of interest in the product, a court ruled they worked like a futures contract and there had to be traded on the futures market. The next attempt at the creation of the modern Exchange Traded Fund was launched by the Toronto Stock Exchange in 1990 and called Toronto 35 Index Participation Units (TIPs 35). These were a warehouse, receipt-based instrument that tracked the TSE-35 Index. Three years later, the American Stock Exchange released the S&P 500 Depository Receipt (called the SPDR or “spider” for short) in January of 1993. It was very popular, and it is still one of the most actively-traded ETFs today. Although the first American ETF launched in 1993, it took 15 more years to see the first actively-managed ETF to reach the market.
Why is this Important?
ETF’s revolutionized the game. For people who didn’t want the activity of the mutual fund and subsequent fees, the ETF was a great alternative. The ETF mirrors an index, meaning it copycats indices like the Toronto Stock Exchange, Dow Jones and S & P 500. Because it does not deviate from the index it copies, it doesn’t require much in form of maintenance. This means it can keep costs low. It is important to remember that all investing has a fee. ETF’s are sold as the low-fee alternative to Mutual Funds. You can invest in ETF’s from around the world and in all sectors, just like mutual funds.
5 Important Investing Tips for Young People – Budget Boss
Where I Stand: The Pros and Cons
There are positives and negatives to each of these types of investing. I have experienced first hand that active management does work, making mutual funds very appealing to me. I am also quite aware of poor-performing mutual funds with poor managers and high fees. These funds can zap your savings and should be avoided at all costs. I am also quite familiar with the fact that index funds are a great method of investing for those who don’t want to worry too much about their investments. I also like the low fee alternative, meaning that I agree that high fees can eat away at savings.
I do however disagree with some of the Index Fund proponent’s false claims that Mutual Funds cannot beat the Market. History has shown that mutual funds can outperform the market. Do all Mutual Funds outperform the market? Hell no! But good ones do, and they do it regularly. I also know one rock-solid fact about ETFS’s: They will never outperform the market, ever. They are specifically designed to mirror the market and slightly underperform it as there are fees, even with ETF’s. Index Funds also are the do it yourself version of investing, so for those who need a helping hand, you are often out of luck.
The reviews are mixed with passive fund manager Wealth Simple. Most negatives hinge on service.
Ultimately, I believe that both styles have their positives and negatives and it is up to the investor to decide what is right for them. I look to Mutual Funds as a great form of investing for growth and loss protection in bear markets. I look to ETF’s for a lost cost alternative. Both have their place. Education is what’s important for the investor to decide what’s best. Always be wary of any advisor who vehemently shuns one or the other. It usually means they have an agenda.
Thanks for tuning today as Market Week continues at Budget Boss. Tune in tomorrow as we wrap up the week with some investing tips to get the most out of your money. If you would like to start your own investment account, please message me at joe@budgetboss.ca. Have a great day friends!
“The biggest risk is not taking any risk… In a world that changing really quickly, the only strategy that is guaranteed to fail is not taking risks.” – Mark Zuckerberg
Email – joe@budgetboss.ca
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