Andrew Hallam is the index investor for Strategy Lab. Globe Unlimited subscribers can view his model portfolio here and read more in the series online here.
It's a good thing Napoleon Hill's classic book, Think and Grow Rich, wasn't about mutual funds. If it were, it would have been a dud.
Success, according the author, comes from channelling desire, faith and persistence. That might work in sports and business. But it doesn't work for mutual fund investors.
Investors in actively managed funds usually think about two things. They wonder how stocks will perform, and they wonder how well their chosen funds will perform against the market.
Most investors add more money when their funds do well. They sell or cease to buy when their funds sink or lag. This kind of behaviour can really kill profits. In the United States, Morningstar tracks mutual fund performances and compares those results with how well the typical investor in each fund performed. Take Fidelity's Magellan Fund. Over the 10-year period ended Aug. 31, it averaged 5.64 per cent a year. But its average investor earned just 1.79 per cent over the same time period.
Over the 10-year periods ended 2012, 2013, 2014 and 2015, Morningstar found that the typical U.S. investor underperformed their funds by an average of 1.13 per cent a year. That might not seem like much, but it's huge. If somebody invested $200 a month for 35 years at 7 per cent a year, the money would grow to $354,992. If the investor gained 1.13 per cent less a year (5.87 per cent) it would grow to just $275,425. The typical investor would give up $79,567. That's the cost of thinking.
Index fund investors also underperform their funds – but not by as much. The Wall Street Journal's Jonathan Clements asked Morningstar to calculate which investors behaved more rationally. Was it index fund investors or those in actively managed funds? It turns out that index fund investors captured a higher percentage of their funds' returns, compared to investors in actively managed funds.
That might be because index fund investors don't have to think about fund selection. They just accept the market's return. That just leaves decisions (or worrying) about asset allocation. Will U.S. stocks beat Canadian stocks? Is it the right time to buy stock or bond funds?
Removing those decisions might juice returns.
In the United States, Vanguard offers Target Retirement funds. They're low-cost global balanced funds made up of different indexes. Over the 10-year period ended Aug. 31, the typical investor in these funds outperformed their funds by an average of 1.02 per cent a year.
Most likely used dollar-cost averaging. They invested the same monthly sum and didn't jump around. This allowed them to buy fewer units when the fund prices rose and more units when their fund prices fell. They didn't have to speculate about asset allocation because the funds were rebalanced, once a year, back to their original allocation.
Such funds might offer investors a behavioural panacea. But they aren't available in Canada. Fortunately, Tangerine provides the next best thing. They offer four index funds. Each represents a diversified portfolio based on different risk tolerances. Their MER costs are 1.07 per cent a year. That's a lot higher than the 0.14 per cent that Vanguard's Target Retirement fund investors pay. But it's significantly cheaper than the global balanced funds sold by Canada's banks.
RBC's Global Balanced Fund costs 2.21 per cent a year. CIBC's Managed Balanced Growth Portfolio costs 2.46 per cent. TD's Balanced Growth Fund costs 2.22 per cent; BMO's Fund Select Balanced Portfolio A costs 2.57 per cent; and the Scotia Balanced Opportunities Fund costs 2.08 per cent a year.
Each fund contains similar allocations to Tangerine's Balanced Portfolio. They each contain a mix of Canadian, U.S. and international stocks. Their bond allocations are close to 35 per cent.
Tangerine's Balanced Portfolio was launched in January, 2008, right before the market crash. Did the actively managed global balanced funds offered by the Big Five banks stickhandle around that mess? Nope. Since 2008, Tangerine's Balanced Portfolio gave them all a beating. Between January, 2008, and Sept. 31, 2016, Tangerine's Balanced Portfolio beat the banks' actively managed global funds by an average total of 14.82 per cent.
Global balanced fund comparisons (Jan. 1, 2008 – Sept. 31, 2016)
| Fund | MER | Total Gain |
| RBC Global Balanced Fund Series A | 2.21% | 27.81% |
| CIBC Managed Balanced Growth Portfolio | 2.46% | 44.13% |
| TD Balanced Growth-I | 2.22% | 34.44% |
| BMO Fund Select Balanced Portfolio A | 2.57% | 33.77% |
| Scotia Balanced Opportunities | 2.08% | 50.07% |
| Tangerine Balanced Portfolio | 1.07% | 52.86% |
Source: Morningstar.ca
I used to scoff at Tangerine's MER of 1.07 per cent. I thought it was too high. But what if Tangerine's investors, such as Vanguard's Target Retirement investors, can outperform the funds they own? In that case, they won't only beat the average actively managed fund. They'll also stomp a lot of index fund investors. When it comes to investing in mutual funds, it might pay not to think.