How to Invest Your Money » Mutual Funds

I Should Have Bought An Index Fund

An index fund is a mutual fund that tracks a certain index. Large market indexes include the S&P TSX, Dow Jones and S&P 500. Index funds based on these indexes are a great way to invest in the stock market without buying individual stocks or actively managed mutual funds. Unfortunately, I didn’t always know about index funds. My first time investing, I went into the bank to open an RRSP account and I chose an actively managed dividend fund with a good 5 year history.

Though I hadn’t invested before, I thought I knew what I was doing. I read a bit online, found a mutual fund with a good track record and a MER below 2%. I knew dividends can greatly help your long term returns so I figured dividend funds would be a good choice. So why do I regret the investment?

Past History Does Not Indicate Future Performance

While it’s great that a mutual fund had a solid five years of returns, it doesn’t mean that the next year will do just as well. In fact, there are studies that indicate it’s all the more likely that the fund will have a bad year. Not only do all investments have their ups and downs, but there are other factors such as a major change in the portfolio of the mutual fund or even a new fund manager behind the scenes.

Management Expense Ratio

A Management Expense Ratio (MER) of around 1.7% isn’t necessarily considered high when there are other funds at 2.5%. However, considering I now don’t invest in any mutual funds with MERs over 0.5%, this means I was losing at least 1% of my return in my previous mutual fund.

Mutual Fund Not Sticking To It’s Purpose

When trying to set up a balanced portfolio, you might pick certain funds to fill a missing piece, whether it’s a certain industry, country, or type of investment. So if you’re looking for a Canadian dividend fund, you need to be aware that you’re not only getting Canadian dividend paying stocks in that fund, but anything else a fund manager may decide to add in an attempt to increase the return.

How I Started Investing In Index Funds

I was lucky enough to cash out my mutual fund through the Home Buyers Plan near its peak price, and before the crash in 2008. Then I decided to setup a TD e-Series Funds account, buying the TD U.S. Index and TD International Index. In a few years I plan to add the TD Canadian Bond Index to reduce the risk of an all-stock portfolio.

Comments

  1. Rob Bennett

    I love index funds. My personal belief is that even most indexing advocates do not today realize all the benefits of investing. Indexing is just going to grow over time. John Bogle started a middle-class investing revolution!

    That said, there are also huge risks to indexing that many overlook. When you index, you don’t have to study the companies. That makes investing an artificial and theoretical project. I think this is why many indexers don’t pay enough attention to valuations (stocks are far more risky at times of high valuations than they are at times of reasonable valuations) and thereby hurt themselves.

    Indexing had huge potential. But we need to learn how to do it right.

    Rob

  2. Dd

    I like index funds as well. Though i currently do not hold any, I believe they are a very safe way to keep up with the market returns.

    I used to use them as a hedge… but became too impatient 😛

  3. Balance Junkie

    Index funds can be a great way to set up a basic asset allocation model. I prefer ETFs, but if you are contributing monthly, I think something like the eSeries are the better way to go.

    Our first (and worst) investment was in Labour Sponsored Funds many years ago. We are finally free of them, but it wasn’t a fun ride! 😉

  4. Craig Ford

    Tom,
    If could go back I’d probably also start with Index funds.

  5. RetirementInvestingToday

    This was one of my mistakes as well. For me though I went even further than yourself by investing in an actively managed leverage share fund with annual fees of 3.22%! Obviously this fee was justified because of the superior skill of the fund manager [sic].

    Now my strategic and tactical asset allocation strategy is built around low cost index trackers and ETF’s.

  6. CC de Mes Finances Perso

    I read a lot of material before I started investing, but what really made me decide to start investing was the Boglehead’s guide to investing book.

    Incredible stuff =) I decided to go with the e-series funds too, as they are convenient and inexpensive for us, canadians.

    Last week, I have setup everything with “Systematic investment plans”, which invests the money automatically in all of my funds every twice/month. Soooo convenient, and you can invest as little as 25$ per fund instead of the 100$ minimum if you’re buying manually.

    Dollar-cost averaging + Index funds = Long-term success 😀

  7. Andrew Hallam

    So many investors have this love/hate relationship with the Canadian banks. They charge expense ratios for their funds that are among the highest in the world—yet if we’re smart enough, we join them in the exploitation while owning their shares. I guess you could call the process Darwinian. Buy ETFs/Indexes and bank stocks, while leaving the actively managed mutual funds to those who don’t care to figure it all out.

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