What is a mutual fund?

Investopedia defines a mutual fund as “an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.”

Each mutual fund tries to attract investors by boasting a unique strategy. This claim to be worth your commission dollars can be based on anything, from sector-specific strategies to geographic-specific strategies. Some mutual funds allocate a portion of the funds to bonds or other more uncommon asset classes.

Mutual funds are an active form of investing, as their managers invest directly in stocks and bonds, rather than index-linked passive investments such as basic vanilla ETFs. Robo-advisors on the other hand, automatically invest in passive investments like ETFs and don’t try to actively “buy low, sell high” or pontificate on if a butterfly flapping its wings in Australia will affect the options market on copper!

So, what’s the catch?

There’s no catch, per se, but mutual fund managers don’t operate a charity. You can expect a hefty commission fee, called a management expense ratio (MER), which is expressed as a percentage of the overall assets (whether you make money that year or not). The average MER can range anywhere from 1-3% and can add significant costs to the investment.

Best active investing mutual funds in Canada

Lately, the mutual fund industry has seen the rise of low-cost mutual funds, which offer investors an active investment alternative at a price much more reasonable that the traditional mutual funds that Canadians have watched their money flow into over the years. Two notable Canadian examples are Steadyhand and Mawer funds. The Mawer Balanced Fund has an MER of 0.96%, and the Steadyhand Founders Fund 1.34%; both well below the average charged by conventional funds.

The Steadyhand Founders Fund is fairly new, having come into being in February of 2012. This fund invests in a balanced portfolio of stocks and fixed-income securities. Since 2012, it has yielded a cumulative return of 31%, which is equal to an annualized return of 11%, according to its latest quarterly report.

The Mawer Balanced Fund, on the other hand, was created in 1988; and invests primarily in Canadian, US, and International equity securities, as well as bonds. The Balanced Fund had a 7.8% return for the year to Sept 30, 11% annualized return over five years, and a 7.2% annualized return over 10 years.

What is a robo-advisor?

A robo-advisor is essentially an online portfolio manager. For a more thorough explanation check our guide to Canada’s robo-advisors. When most people hear the term ‘robo-advisor,’ they conjure up images of impersonal machines arbitrarily investing their money in cookie-cutter strategies. The fact is, that it’s nothing like this!

Robo-advisors simplify investment for passive investors, by offering a limited range of portfolios, usually based on exchange-traded funds (ETFs). These same systems routinely adjust portfolio weightings in different asset classes, based on market conditions – after you have set up your original portfolio with the help of a flesh-and-blood human being that has a legal responsibility to put your interests first. Not every investor receives the same portfolio from these automated systems. Robo-advisors rebalance client portfolios when the balances vary from the pre-agreed upon levels.

Steadyhand & Mawer funds vs. robo-advisors: Pros and cons

So, which option is better? The answer to that question depends on a number of different factors. While both methods offer investors a vehicle for secure growth, there are distinct differences between the approaches taken by robo-advisors and low-cost mutual funds.

As previously mentioned, robo-advisors typically invest using index ETFs, which are generally considered a passive form of investing. Mutual funds, on the other hand, invest directly in stocks and bonds as they seek to pick “winners”.

So really the choice when comparing market-leading mutual funds such as Steadyhand and Mawer (which are far better options than most Canadians are invested in due to their low fees) to robo-advisors is simply whether you believe in the value of cutting costs to the bone, while passively investing your money.

Passive vs active = mutual funds vs robo-advisors

Proponents of active investing believe that the main advantage lies in the assumption that the mutual fund managers will be able to outperform the index due to their superior skills. They believe that these managers are able to make informed investment decisions based on their experiences, insights, knowledge and ability to identify opportunities that can translate into superior performance.

Mutual fund managers have the ability to re-balance the fund between equities, fixed income securities, and cash; based on market conditions; whereas passive investors tend to take a longer-term view.

Passive investing proponents, on the other hand, believe that the key to stability and long-term growth lies in constructing a diversified portfolio designed to closely match the performance of the broader stock index. Robo-advisors do this by using ETFs that track broad-based market indices based on market capitalization.

Empirical evidence anyone?

According to a research report for Standard & Poor’s released in 2017, over the last 15 years, 92.2% of large-cap funds lagged a simple S&P 500 index fund. The percentages of mid-cap and small-cap funds lagging their benchmarks were even higher: 95.4% and 93.2%, respectively. In other words, the odds you’ll do better than an index fund are close to 1 out of 20 when picking an actively-managed mutual fund.

If you want more proof of passive investing success versus mutual funds, check out our guide to ETF investing.

Personally, while I commend Mawer and Steadyhand for offering products that are objectively much better and much cheaper than those of their competitors, the basic long-term math of index investing doesn’t lie. Canadian robo-advisors such as Wealthsimple and Nest Wealth are simply better bets due to their adherence to passive investing strategies. There is no need to try and outperform the market – just keep things simple, invest a monthly portion of your income, and forget about the futility of trying to “pick winners”.

READ MORE: TD eSeries Funds vs robo-advisors

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