Canadians are investing the cash they have been saving since the onset of the pandemic and their choice of investments seems to be split between active management and doing it themselves.
According to Statistics Canada, households have been putting their savings into actively managed mutual funds at near-record levels. Net purchases of mutual funds reached $105.5 billion over the last year, more than three times the amount registered in the comparable period a year earlier, the data agency recently reported.
At the same time, discount brokers have been reporting a surge in the number of do-it-yourself (DIY) investors ditching professional advice and going it alone.
According to research firm Investor Economics, Canadians opened more than 2.3 million self-directed investment accounts in 2020; nearly three times the previous year.
For Canadians with cash who don’t know whether to put their money into mutual funds or take matters into their own hands, here are some things to think about.
MUTUAL FUND PROS
Most Canadians save for retirement through mutual funds; often in registered retirement savings plans (RRSP) or through defined contribution company pension plans. For the average investor with modest savings, it’s the only way to get access to a professionally-managed, diversified portfolio that can include just about any sector in any geographic region in the world.
Mutual funds are also popular with average investors because investments can be made in fixed amounts on a regular (normally monthly) basis and require little oversight on their part.
MUTUAL FUND CONS
On the downside, high mutual fund fees can eat into returns. Canada has some of the highest, and most complex, mutual fund fees in the developed world. Annual fees, expressed as the management expense ratio (MER) or a percentage of the amount invested, can top 2.5 per cent. Within that MER, an annual commission called a trailer fee is awarded to the adviser who originally sold the fund.
A recent report from Ontario’s auditor general criticized the Ontario Securities Commission (OSC) for dragging its feet in banning some types of mutual fund fees, estimating they have cost investors $13.7 billion since 2016. Trailing commissions have been banned in Britain and Australia since 2012.
Performance data over several time periods show the average Canadian mutual fund underperforms its benchmark index once fees are taken into consideration. That means many mutual funds consistently beat their benchmarks even with fees; but limited disclosure requirements make it difficult for the average investor to contrast and compare to find the best ones.
DIY PROS
The biggest shift in DIY investing is coming from younger Canadians who want fewer of their dollars going toward fees and more invested. Fees translate into a certain loss regardless of how the investment performs.
As an example, a 2.5 per cent MER on $100,000 in mutual funds amounts to $2,500 not invested, and not compounding over time. Over a lifetime of investing, fees can reduce retirement savings by hundreds of thousands of dollars.
DIY investors with modest portfolios can also gain access to a diversified array of sectors and geographic regions through exchange-traded funds (ETFs) linked to the same benchmarks mutual fund managers track, at a fraction of the cost. The MER on a basic S&P 500 ETF could be as low as one-tenth of a percentage point.
In addition, there’s nothing to prevent a DIY investor from investing directly in the stocks most common as top holdings in mutual funds, such as the big Canadian banks.
Hands-on investing can also yield a wealth of knowledge about the markets and economy; especially for young investors with less to risk and more time to learn from their mistakes.
DIY CONS
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.
Professional managers often have the skill to put hedges in place to offset risk, mainly through diversification. One common hedge against volatile equity markets is allocating a significant portion of a portfolio to fixed income, which only yields about one per cent a year but can keep a portfolio above water if stock markets tank.
Young DIY investors who have known nothing but bull markets in their lifetimes are more prone to gravitate towards speculative trends with high return potential over the short term such as cannabis stocks, cryptocurrencies or whatever comes next.
Professional money management can take the all-or-nothing, casino mentality out of investing and protect DIY investors from their own worst instincts.
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