The Problem With Owning Lots of Mutual Funds

A long time ago I wrote about why having lots of mutual funds is a bad idea. Namely, lots of overlapping mutual funds of the same type, like Canadian equities, for example. In my case, I owned 4 TD large-cap Canadian equity funds. The punchline is that with so many funds and so many underlying stocks, I was starting to get so diversified that I was about as diversified or more so in the Canadian large-cap market than an index. But I was paying exorbitant MERs on the mutual funds, at least 1-3% whereas I could have just bought 1 index ETF and paid 0.17% MER. A 1-3% difference in performance is huge over the long term.

Tom Bradley at SteadyHand just wrote an article about the exact same thing, however, the example in his case is far more extreme: “The featured couple had registered retirement savings plans totaling $170,000 that were spread across 29 mutual funds.”

I’ll summarize his analysis:

Holding 29 funds is ridiculous whether you’re investing $170,000 or a million dollars . . . But more than anything, owning 29 mutual funds means you’re seriously over-diversified . . . If we assume that there were 45 unique stocks per fund, that’s 900 stocks plus the ones that showed up in multiple funds. Let’s say you own 1000 stocks. What you really own is a very expensive index fund.

and the conclusion/recommendation:

Through exchange-traded funds (ETFs) you could get the same market exposure for an average fee of 0.25 to 0.30 per cent a year on their management expense ratios. I hazard a guess that the couple in the article were paying in the neighbourhood of 2.5 per cent. It is no wonder they were disappointed with their mutual fund returns.

I suspect that there are many Canadians in a situation similar to the one that I was in, or similar to the one the couple above was in. My guess it that there is a subset of those people who DO look at the MERs on funds (so they are thinking about cost a little) and given two funds, will choose the lower MER one over the high MER one. But most probably fail to think about their cost relative to an index ETF and their risk-adjusted return relative to an index ETF.

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