Crucial But Basic Math That Canadians Are Being Hurt By

Sometimes 2% = 25%. What?? Watch this very important video (and share)!

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Very few professionally managed mutual funds outperform the broad market. Remarkably few, actually. Remarkably few squared, actually. In other words, investors who purchase index funds for their equity exposure, outperform the vast majority of investors who purchase conventional mutual funds. Those seeking outperformance instead find underperformance.

Over and over and over again with scant few exceptions. Why? Why do even the very sharp, well-trained, hard-working, professional money managers consistently struggle to keep up with the market returns available through index funds? Well, there are a number of reasons, including one that I don’t think gets enough attention.

I’m saving that for a later video. But a big reason is a basic one – the professionally managed funds’ not-so-tiny fees. What I’m about to walk you through is incredibly important, so please pay attention. Let’s say a fund’s MER, its management expense ratio, is 2%. The MER is what the fund company charges the fund’s assets on an annual basis.

Now you say “2% – that doesn’t sound like much. Can’t a brilliant fund manager outperform the market by a mere 2%? C’mon!” Perhaps, but here’s the problem: The manager doesn’t have to outperform the market by 2% to add value, but, instead, by much, much more, say 25%. What? Stick with me. Let’s say the Canadian market continues to average around an 8% annual return going forward.

Some years better, some years worse, whatever. So if the MER is 2%, what performance would have to be achieved to leave the 8% the investors need to match the market? That’s right, 10%. Ah, but 10% is not 2% bigger than 8%, it’s 25% bigger. 10-8 is 2, and 2/8 is 25%.

Outperforming market returns by 25%, that is very hard. This is basic math but it escapes a lot of people, including a lot of industry people. Vitally important to recognize this. You know, I left out there is a very small fee in the index fund, the 2% MER often includes compensation for an advisor who may well add value through financial planning, etc. But my basic message holds.

It’s extremely difficult for professionally managed mutual funds to keep up to an index-fund performance. We’ll look at how much that underperformance can cost investors soon. Hold your breath.