Mutual Fund Madness?

T-Rex Score of 28%?? WTF?!

(Just to be clear, WTF? stands for What’s The Fee?)

Short term changes in the value of bond mutual funds and ETFs are driven by day to day interest rate moves. But for long term bond fund investors, short term changes in market values don’t mean much. Two factors really count:

  1. Yields
  2. Fees

Yields on bonds held in Canadian bond mutual funds and ETFs currently average around 2% to 2.5%. It’s not much, but these yields are relatively stable. But how much of that yield will you get to keep after fees?

Let’s look at the $2 billion National Bank Bond Fund. The average bond yield to maturity in this fund is 2.22% while fees are 1.59%. Assuming yields and fees remain static, investors in this fund will receive an annual net return of only 0.63% (2.22%-1.59%). Your T-Rex Score in this case is only 28%. In other words, only 28% of the benefit is yours to keep while 72% evaporates in fees! Most Canadian bond mutual funds produce similarly shocking T-Rex Scores.

Madness? What do you think?

Alternatives

If Canadian bonds make sense as part of your portfolio, what are some of the alternatives?

  1. Buy low fee Canadian bond index funds (from providers such as Blackrock, Vanguard and BMO) which provide similar yields but with T-Rex Scores of 85-95%
  2. Buy high-quality government bonds and keep 100% of the return……my online broker is offering an 8 year Ontario bond at a yield of 2.3%
  3. Buy a 5 year GIC with a yield of 1.80% (only if you are sure you won’t need the money sooner)
  4. Buy a cashable GIC with a yield of 1.30%

To learn more about bonds check out this site sponsored by the Ontario Securities Commission.

Every investor has a T-Rex Score. What’s yours?

3 thoughts on “Mutual Fund Madness?

  • Brian Fraser

    Okay, but if you invest $100,000 for 10 years to earn an average of 7% per year and your fee is 1.50% it costs you $25,900 in fees. But, let’s say that fee was for service and thus tax deductible. Assuming a 50% marginal tax rate the actual cost is $13,000 or just over $100 per month on average for the “expert” advice. This seems more reasonable to me. So, if you are going to pay high fees, then you should at least try to get them tax-deductible.

    Reply
    • Larry Bates

      Good point Brian. Deduct fees whenever possible. I am not a tax expert but here are a few points:
      1. If the 1.5% fees in your example are embedded in a mutual fund, the fees will simply be deducted from the total pre-fee return of the fund so you would just end up keeping a 5.5% return after fees.
      2. If your fund is held inside a RRSP, taxes are deferred but gains will ultimately be taxable when funds are withdrawn
      3. Fees paid directly to an advisor related to taxable investments would typically be tax deductible but of course your gain would be taxable.

      Reply
  • Larry Bates

    Good point Brian. Deduct fees whenever possible. I am not a tax expert but here are a few points:
    1. If the 1.5% fees in your example are embedded in a mutual fund, the fees will simply be deducted from the total pre-fee return of the fund so you would just end up keeping a 5.5% return after fees.
    2. If your fund is held inside a RRSP, taxes are deferred but gains will ultimately be taxable when funds are withdrawn
    3. Fees paid directly to an advisor related to taxable investments would typically be tax deductible but of course your gain would be taxable.

    Reply

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