Will Mutual Funds Disappear?

By: Pete
Date posted: 03.21.2012 (12:42 am) | Write a Comment  (0 Comments)

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I think it’s a fair question to ask. A lot of different people have called the end of mutual funds and clearly, the momentum is clearly much greater for ETF’s. Why? Many posts describe the advantages of ETF’s over mutual funds, the biggest being lower fees of course. Added flexibility is also a big part of it. Funds want to have the ability to get in and out of trades during the day, to actively trade them, etc.

ETF’s > Mutual Funds

In almost all cases, ETF’s turn out to be much better than mutual funds. Personally, the only case I can see where it’s not the case is when an investor doesn’t have enough money to buy ETF’s (given the impact of commissions) and wants to invest in the meantime. In such a case, investing for a few months in a mutual fund can turn out to be a good proposition. It is important to make sure that there are no additional fees for early exits though because those could erase all gains made.

That being said, in almost all other cases, it is much better to buy an ETF. While the average mutual fund charges north of 1% of annual fees, most ETF’s now trade a fraction of that (under 0.20% for many big ETF’s).

Another big point is that ETF’s give us much more flexibility in how we reinvest dividends, change the asset allocation, etc. It makes it possible to also change allocations of certain sectors over time, etc.

Mutual Funds Are NOT Doomed

I think that over time, ETF’s will catch up to mutual funds in terms of assets under management but that does not mean mutual funds will end up dying. I think 2 big reasons why mutual funds will remain an important part of asset management are:

Payment structure: the fact that brokers that buy mutual funds for their clients receive a commission that is recurring every year becomes a major incentive for them to buy mutual funds even thouggh it might not be the best product for the client. It’s not fair but until the government makes it mandator for brokers to buy the best product for its clients (which would be next to impossible to enforce), I can’t see it happening. Some higher net worth clients are able to get brokers for a fixed fee which gives them an incentive to work on the highest possible returns but only the richest of us can afford to get such a broker.

Reduced Fees: This has already started. Mutual fund companies will continue to be forced into reducing their fees in order to make them competitive with the MER’s charged by ETF’s. This process will take a lot of time but I do believe it will end up happening which will be a great thing. The margins that the mutual fund companies can make on these fees remain very high so they will be able to reduce those fees when they will feel like they have no other alternative.

That being said, don’t expect me to recommend mutual funds anytime soon.

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