Category Archives: Passive Investing

Are Mutual Funds a Good Investment?

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I think this is a very important question to ask yourself because many people out there get manipulated strung along when it comes to investing. The fact is that most of us simply don’t have the time to learn how to invest properly. We are busy. I think there is a very fair argument that you’re probably better of making the money to invest, rather than worrying about where you’re going to invest it. But for me you need to face facts. No one is going to look after your money as well as you are. You earned it and you don’t want to see it wasted.

There is so much misinformation out there that it is confusing. Are mutual funds a good investment? If you went to a bank and spoke with a financial adviser you’d probably think so. I think before you ever speak with an adviser, you need to educate yourself first. I’m not saying you need to know everything, but you need to know enough. You don’t want to be taken advantage of.

Financial advisers at banks are pretty useless. The reason why I don’t like them is that they really don’t know anything. They’re not experts per say. They’re more salesman. They sell the mutual funds of the bank promising you big returns. In fact, they’ll dig out pretty looking charts and show you how well it has been working in the past. I have to admit that these charts look great, but I’ve yet to find one that actually performs like that. What is often missed out is the higher MER or management cost. It’s a cost to you, but it’s hidden in the fund. A lot of mutual funds run at 2%.

Most actively managed mutual funds won’t beat the market. The point of this site is to show you another way of doing things and that is buying passive index funds. The MER or management cost is a fraction of a precent. You come up with an asset allocation that you’d like and just buy. There’s no real thinking beyond that. Passive index funds are designed to follow the market and as you know the market produces pretty good returns over the long run.

Let’s take a look at a very popular passive index fund like TD e-series and compare it against my work’s mutual funds from Manulife.

Canadian Equities

Here is a look at Canadian equities between both the passive fund (TD Canadian Index-e) and the active mutual fund (Manulife Canadian Equities). You can click the image to get a closer look, but the red is the passive and the blue is the active mutual fund. Over a period of roughly 5 years, the passive fund outperformed the mutual fund by 12%. That’s a lot of money. And the reason it out performed is that it didn’t charge high fees hidden in the fund as MER and it didn’t try to guess which stocks would be winners. Really can anyone predict the funds that will be the winners?

Canadian Bonds

Unfortunately TD e-series bond fund is much different than the the Manulife Canadian Bond Fund, it wasn’t fair to compare them both. The passive fund held mainly Canadian bond/provincial bonds, whereas the Manulife one held a lot more corporate bonds. But as you can see in the graph above, the Manulife one under performs its appropriate index. There are other passive funds out there that follow this index and will out perform this mutual fund. Over the last 4 years (since this fund isn’t that old) it has unperformed the market by around 6%. That’s 6% of your money lost and paying the bank or Manulife in this case.

Are mutual funds a good investment? No they’re not. You’re better off investing in passive index funds. It’s cheaper, it’s easier and you’ll make more money over the long run.

When to Rebalance a Passive Portfolio?

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When you have a diversified portfolio of funds, you’re going to experience variations in the values of these investments. Some will grow fast. Some will grow slow. Some will lose money. The whole point of having a balanced portfolio is to control risk and allow you to reach your goals.

I’ll give you a portfolio that I’m currently following and what I aim for when it comes to balancing the funds.

  • 25% – S&P/TSX Composite Index
  • 25% – DEX Universe Bond Index
  • 25% – S&P 500 Index (in US Dollars)
  • 25% – MSCI EAFE Index (it’s international)

I just gave the indexes that my investments follow instead of getting into the actual funds/ETFs that I hold. This portfolio is something designed for the long term, hence why I have only 25% in bonds.

The fund allocations I have aren’t even close to meeting that goal. Some of the funds are at 37% of the total portfolio, while others are at 18%. I do have one at 25% though.

The question now is when should you rebalance and the answer is probably going to have a little more market timing than I’d normally want. I’m not going to go into the details because there are other passive investing blogs on the internet that have done these calculations.

Rebalancing at the end of the year

This is probably a pretty passive and objective move. It will keep your risk tolerance in line exactly how you like it. The problem with this type of rebalancing is that when there is a bull market you often miss out on a lot of gains. The reason for this is that you’re most likely selling your equities (which are growing) and buying bonds (which are slow). Over a long enough run you’re missing out on a lot of gains.

So if you look up the stats for a person that invests for retirement and over the years there are more bull markets than bear markets you’ll find that they’d be ahead if they didn’t rebalance.

Never Rebalance

Like I mentioned in the previous point, bull markets will yield you a better result. There is another side of the coin and that’s when you tend to be in a bear market or an uncertain market. The more you rebalance in this market the better off you are.

Use New Money to Rebalance

This is something that I’m currently doing to rebalance my portfolio. I can get away with this because I’m younger and I don’t have a massive net worth built up over decades. I do think this is a good approach. You’re balancing your portfolio without actually changing things around and potentially selling a winning fund to rebalance.

What should you do?

I really can’t answer this question for you because it’s up to you to figure out. It really boils down to how much you value your risk tolerance. We all know that riding out the storm or the bull is the way to go. I plan to just keep pumping money in and try to rebalance that way. I know that can be a losing battle when you’re up several hundred thousand dollars, but it’s fine. I’ve heard that you should rebalance every 4 years, but who knows.

The point is that you have to come up with an objective way of looking at it. You can’t make rash decisions. I like the 4 year one because it allows the market to run the course and takes a lot of reaction away from us.

Canadian Claymore ETFs – Worth It?

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Like most of us, passive investing in Canada makes us subject to a very slim and noncompetitive options. I think with Claymore entering the market up here has really opened the door to more competition and that is really what we need at this time. Whether they’re good or not, having more choice on the market really gives you a chance to try out new things. I know I was pretty excited when I first saw them come on the market and there was a lot of excitement on forums on the internet.

If I was to lead with the positives, Claymore offers a lot of niche type of funds that allow you to get into some interesting. Some of the big ones that pop out for me is the Claymore Oil Sands Sector ETF and the Claymore S&P Global Water ETF. They’re definitely pretty interesting areas of the market and allow you to diverse up your total portfolio that way.

Another big benefit upon release is that Scotia iTrader offered the funds at commission free. This is definitely the competition that we all want to see enter this market. And I can only hope that more competing funds will end up doing the same thing.

No American Style Management Fees

The thing that upsets Canadians the most that do passive investing is that the MER (Management Expense Ratio) in this country is no where near as cheap as it is in the United States. While Americans can get funds and indexes with 0.10%-0.25% we’re running up into the 0.30%-0.75% range.

I hate to report the Claymore ETFs are mainly in the 0.55%-0.75% range. Most of them are really around 0.65%. The only place that you find very low management fees is with Fixed Income items. In particular, the Claymore 1-5 Yr Laddered Government Bond ETF only has a MER of 0.15%.

My opinion is that it really isn’t worth it. You’re not saving anything by using their funds. You can get by perfectly fine as a small trader using cheap index funds from TD. And if you have more money where buying ETFs is worth it you can go with iShares or something along those lines.

The only reason I would really buy Canadian Claymore ETFs is if I was trying to get into very diverse markets. It seems like a very active choice for me, instead of the passive investing that I’ve chosen to do. You may think that the commission free ETFs are going to make up for it, but if commission costs are eating up too much profit (ie: new investors) you should probably be sticking with index funds that are free to buy.

Buy Low & Sell High With Passive Investing

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When it comes to a passive investing strategy the one thing you’re forbidden from doing is timing the market. The reason for this is that you’re starting to want to beat the market and make active decisions, the same thing that active mutual funds and other big wigs try to do with the market. I had the hardest time understanding this point because I think the most universally accepted view is buy low and sell high.

If you look at the S&P500 and if it falls below 800 points, the only thing that would pop into my head is buy buy buy. I was literally thinking of keeping a nice chunk of cash on the side just in case there was a market crash of some kind. Though I cannot properly predict when a market is going to head south, I could at least buy on the way down and profit.

I know there are many people out there that can’t shake this feeling. But I’m going to challenge you a bit. If you’re going to build up a nice lump sum to dump into a crash, how much are you going to miss out on during the next bull run? Are we going to have a crash in the market soon? I don’t know. No one knows.

Rebalancing is the Key

It took me a while to figure this out, but the act of rebalancing is the key to buying low and selling high. If you have a well diversified portfolio, you’re going to have some items going up and others going down. The act of rebalancing the portfolio is selling some of the higher growth funds/indexes and buying some of the lower growth/loss funds/indexes. In essence, you’re forced to buy low and sell high if you stick with the gameplan (your portfolio balance).

Whether this is more effective then leaving a lump sum of cash on the sideline in order to buy at a more opportune time is up for debate. Big market crashes come, but they don’t come that often. You’ll often miss out of the bull runs the market presents. If you don’t get most of your money in at the bottom than you’re really not going to return more than what a person would of made investing passively in the market.

Also with timing the market you’re becoming much more active with your investing. Like all of us, we like to see our decisions work out well. If you invest your lump sum at a time that turns out to be not so opportune, can you swallow it?

When it comes to actively timing the market in order to buy low and sell high, it just isn’t worth the risk. Even though there is a lot more money to be made if you buy right in at the bottom, the likelihood of you buying in at the bottom is slim.

Passive investing with a defined asset allocation that you objective rebalance is about the best type of buying low and selling high that you can get. I think it is the best choice and I suggest you stick with the game plan.

 

What is a Passive Investing Strategy?

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If you’re someone that has done any sort of research into investing you probably came across the phrase “passive investing” in one form or another. Another name you may hear is “index investing”, but I suppose that could mean other things. In the investing world this really isn’t the most popular strategy. It isn’t a strategy that promises you huge returns. It doesn’t require a lot of sophisticated trading techniques. It doesn’t even involve that much thought at all.

So what is passive investing? Well, it is a game plan where you try to match the market, rather than beat the market. I know this is a lot of you probably put an odd look on your face. “Not try to beat the market?” When I got my first job that actually paid a decent salary, I often envisioned trading stocks on a daily basis, making smart moves. I’m a determined individual and I thought I could learn to best the market.

Why not an Active Investing Strategy?

The market is a harsh place and thoughts of beating the market are often stuck in your imagination. Reality comes crashing down pretty quick. Active investing is a very simple way of saying that you try to pick winners and losers in the market to earn more money. This applies to your own personal stock picking and also applies to mutual funds that do the same. Here are a few things to consider:

  • Market Gains are Zero Sum – If the stock market goes up 5% on the year, that means 5% more wealth has been created. If someone beats the market with an 8% return, that means someone else under perform by 3%. We all can’t be winners.
  • 70-80% Can’t Outperform the Market: It isn’t a matter of having one winner and one loser. Most people end up losing. Active mutual funds that try to beat the market will usually fail about 80% of the time. Not only will they fail, but they’re going to charge you higher fees for it too.
  • Winners are Random: Research has shown that you can’t look at a mutual fund’s past performance to get an idea of how they’re going to do next year. Typically the one at the top of the pack, is the loser next year.

If you’re looking for information on research that backs up these claims than I suggest you take a look at “The Power of Passive Investing” by Ferri. He did a really good job showing the main points I listed above.

Why Use Passive Investing?

Like I mentioned earlier, most people will fail to beat the market. And over a long enough time line the winners will turn to losers. Passive investing just follow the bench marks, so that is the type of return you expect. As you know, following the S&P500 and S&P/TSX Composite will produce great results on their own.
At the end of the day, you’re more likely to lose playing the active investing game. The more stocks and funds you add to the portfolio the more the odds of you losing increase. Here are a few positives to consider:

  • Cheap MER for ETFs and Indexes: MER stands for Management Expense Ratio. Essentially it is the cost of owning a fund be it a passive index mutual fund/ETF or an active mutual fund/ETF. Since a passive fund doesn’t need to hire overpaid stock pickers they can really reduce the cost of the fund. In Canada passive index will run in the range of 0.30-0.50%. Where as an active index mutual fund will run in the range of 2%.
  • A lot Less Work:  Since you don’t have to try to pick winners and losers you can save a lot of time doing other things. The process becomes the process of just putting the money into your account and following your simple passive asset allocation. More or less you’re just sticking to the plan and putting your money in.
  • Less Trading Commissions: Every time you buy a stock you’re going to pay a commission. If you receive dividends, you need to reinvest the dividends and that’s another commission (except in certain situations). The same is true for a passive ETF, but you really only need to own a handful of funds to be well diversified. Think of how many stocks you’d need to own to be diversified. Indexes at some of our banks don’t even have commission prices.

As you can see the passive investing strategy is really quite effective. Instead of playing to win (with high odds of losing), you play to get market returns. Instead of having to invest a lot of time picking winners and losers, you just put your money in to invest to your asset allocation. The key word here is that it is simple and simple works, especially over the long term with your investing.

There are a lot of books that could be written on this subject, but this discussion was a quick overview of what passive investing is and why a lot of people choose to use it.