Index Funds: My Experience as a Financial Adviser

My first job after college, was as a financial advisor, in reality I was a door-to-door insurance sales person. The company offered many financial products, but the only one the company really cared about was the sale of life insurances.

Since I was interested in investments I was interested in selling their investments products, their mutual funds. To be honest, almost all of their mutual funds had a high expense ration which was not a good offer for my clients. There were 29 actively managed funds and just one index fund. The index fund didn’t pay any commission to us, the advisers, so as you can imagine, we didn’t make much effort to promote it.

Index Funds Today

Recently, when I wanted to help a friend start investing in the stock market, we booked an appointment at a local bank. The adviser assessed my friend’s risk profile and then presented a pamphlet with about 40 different bank-branded, actively managed mutual funds. When I insisted on index funds and low-cost ETFs, the adviser informed us that we would need to open a self-directed investment account, as she was unable to assist with those options. Clearly, since the bank wasn’t going to profit from my friend’s investments, they didn’t consider him worth their time.

Investment Companies vs. Client Interests

It’s obvious that financial institutions have little incentive to help clients access low-cost investments. Companies like Vanguard, the leader in index funds and ETFs, don’t pay commissions to advisers who recommend their products. When I was an adviser, I earned nothing when a client purchased a low-cost index fund, and my employer didn’t either. That’s why we rarely promoted them. There were no trailer fees—ongoing service commissions typically around 1%—paid by the mutual fund company to the adviser for keeping the client invested. Why would we recommend something that didn’t pay us? How could we cover our expenses if we weren’t compensated?

The Decline of Actively Managed Funds

But the truth is out. Thanks to a series of academic papers, investment books, and blogs, investors have learned that they’ve been paying exorbitant fees for actively managed funds that fail to deliver the superior performance they promise. The exodus has been significant, forcing many actively managed funds to either lower their prices, introduce their own index funds, or close their doors.

Actively managed mutual funds have not lived up to their promise. Their mission is to outperform the market, but 90% of them underperform over a 10-year period. There are many reasons for this underperformance, which we’ll explore in another blog post.

In short, investors who believed the promises of actively managed funds have lost a lot of money. Collectively, these investors have lost billions of dollars.

We can say that investing in actively managed funds is like paying a tax on ignorance—a tax on those who haven’t discovered index funds or are still enticed by the possibility of outperforming the market.

Luck vs. Skill in the Mutual Fund Industry

Nobel Prize-winning economist Eugene Fama sought to determine if the excess fees charged by mutual fund companies were justified. His findings were eye-opening.

He discovered that only 2% of mutual fund managers had the skill to consistently beat the market, while the remaining 98% failed to justify the extra fees they charged their clients.

Investors Are Waking Up

As you might expect, the big mutual fund companies don’t want you to know this information. But the truth is out there, and people are taking action. More and more investors are abandoning their actively managed funds and switching to index funds and ETFs, resulting in a shift of trillions of dollars. I promote index funds and low-cost ETFs as much as I can, as often as I can.

Take a Second Look at Your Portfolio

If you still hold actively managed funds, it would be wise to take a second look. By eliminating that extra 2-3% in fees, you could save thousands of dollars over the long run. Instead of paying for your fund manager’s luxury car, you could be saving for your grandchild’s education.

Other personal finance blog posts

• Beyond RRSPs: Understanding RRIFs to Secure a Comfortable Retirement
• How Canada’s Old Age Security Program Provides Stability and Dignity for Seniors
• Saving for your kids’ education or for your own retirement?