Get rid of your expensive and poorly managed mutual fund

  • Mutual funds and ETFs are cousins; they are both investment vehicles that allow investors to invest in the market on a diversified basis. However, while a mutual fund (e.g. a US Equity Fund) tries to beat the market, an ETF tries to match the performance of the market. A mutual fund hires expensive portfolio managers and analysts with the sole purpose of finding good deals to invest in. ETFs (e.g. the SPDR S&P 500 ETF) follow a passive approach where no expensive portfolio managers and analysts are needed. Of course, the extra costs mutual funds charge are passed directly to the investors, so they are the ones that pay the bill.

    This difference between these two concepts is subtle but the huge difference in costs is one of the main reasons why there is an increasing interest in ETFs compared to mutual funds.

    However, it is not entirely correct to assume that just selling a mutual fund, such as a US Equity Fund, and buying the SPDR S&P 500 ETF will do the job. It may happen that the US Equity Fund has a bias towards investing in small- and large-sized companies. If this is the case, you will need to replace the US Equity Fund with a combination of two or more ETFs.

  • Replacing a Mutual Fund with an equivalent ETF will save you money over time

    Regardless of how the market moves, you can start growing your portfolio faster. How much faster? Let’s put some numbers together and compare them.

    Your Initial Investment: $100,000
    Time Horizon: 20 Years
    Market Expected Return: 8% Annual On Average

    ETF Annual Fee: 0.20% (Lower Fees) Mutual Fund Annual Fee: 1.50% (Higher Fees)

    From an initial investment of $100,000 over 20 years, you can save $103,294 in management fees investing in ETFs instead of Mutual Funds.

    Even if some mutual funds beat the market from time to time, there is no mutual fund that consistently beats the market 20 years in a row.

    Comparative Portfolio Growth over 20 years
    (ETF vs Mutual Fund)

    Comparative Portfolio Growth over 20 years (ETF vs Mutual Fund)
  • However, it is not entirely correct to assume that just selling a mutual fund, such as a US Equity Fund, and buying the SPDR S&P 500 ETF will do the job. It may happen that the US Equity Fund has a bias towards investing in small- and large-sized companies. If this is the case, you will need to replace the US Equity Fund with a combination of two or more ETFs.

    Investplex helps you find an equivalent ETF for your current mutual fund allocation

    Investplex uses a return-based style analysis in order to capture the investment style of any particular mutual fund. Looking at this US Equity Mutual once again, a regression analysis is performed between the monthly performance of the fund against the monthly performance of the most relevant US large and small cap indexes looking at both value and growth over several years.

    The results of that analysis show how the US Equity Fund behaves over the long term. Its investment style is a blended style of investing in large cap US (Russell 1000 Index) companies that are both value (Russell 1000 Value Index) and growth (Russell 1000 Growth Index) oriented.

    Basically, any investor holding this US Equity Fund can sell it and buy the IWD (iShares Russell 1000 Value ETF) with 50% of the proceeds from the sale and the IWF (iShare Russell 1000 Growth ETF) with the other 50%.

    Investors will save 1.3% per year in management fees (0.20% vs 1.50%) when replacing the US equity Fund with these two ETFs.

    Investors are also eliminating one very important risk from their portfolio: management risk. They are no longer exposed to the portfolio manager’s mistakes; they are just exposed to market risk—a risk that cannot be eliminated.

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2018-11-19T16:36:57-05:00