Mutual Funds VS Exchange Traded Funds

I have been seeing many posters on Exchanged Traded Funds (ETFs) recently and they are basically promoting ETFs as having superior performance compared to Mutual Funds. Of course, there are many people who would look at these posters and shout “Oh! It’s SGX who puts up these posters, they got to be right since they are such a big company.”

Stop Right There!

Think again… are big companies right all the time? Have you seen big companies swearing that their slimming pills are the best then getting busted due to health concerns? Maybe another example would be a particular company claiming that they have a lot of vitamin C content, only to get exposed by young school girls? My point is not to simply shoot all the big companies since I believe that most big companies are ethical and I definitely respect SGX too. I simply beseech the public to get more facts when it comes to your own health and wealth. Are you alright with that? If you are, let’s move on.

Before I go into comparing the two instruments, let me first briefly explain their differences.

The above table is by no means comprehensive, but I hope it can give you a general idea. A simple way to look at it (but slightly defective) is just to think of ETFs as Mutual Funds that are traded actively on the stock exchanges. Now… as you can see from the table, Mutual funds have higher sales charge, which for some people means eating into their profits. However, there are others who argue that since Mutual funds are more actively managed, it justifies the higher charges. Then, some ETF fans will once again argue that mutual funds perform worst than ETFs, so their active management seems to be a con, instead of pro. I do not side with other extremes, so when it comes to my wealth, I believe in researching and getting facts myself.

Here is what I did… follow the below steps, so that you can get a feel of how to do research by yourself in future. I don’t intend to tell you that something is better without showing you the facts, which often we get such crap everywhere around us. Come on, do some work with me and know that I’m the man for pointing this out.

1. Go to FundSuperMart.com
2. Under Funds Info & Research, Roll Over ‘Funds Info’ and click on Fund Selector.
3. Under ‘Geographical Sectors’, choose Singapore and see returns for the last 10 years.
4. Now… sort everything by 10 years annualized returns.
5. Noticed that every mutual fund that deals with Singapore stocks beat the STI index over a ten year period? As of the time I checked, annualized return for a 10 year period for STI is 6.38, which translates into about growing $1,000 into $1,856 over ten years. Compare that to the only three mutual funds that have existed for ten years and let’s use the worst-performing mutual fund for comparison. At the time I checked, it yielded 11.5%, which translates to growing $1,000 into $2,970 over ten years. If the performance persisted for both STI index and the fund over 30 years… STI will yield about $6,394 while the fund will yield $26,196.
6. Now… sort by 5 years and see the results. Now, you will see many funds losing out to STI right? Yeah, STI beats many mutual funds in Singapore, so it makes sense to get an ETF that tracks the STI. Stop Right There again! Look at the funds carefully… and you will notice that the funds losing out to STI are all money market or bond funds. There is an exception, but even that is not a pure stock fund… it invests in both stocks and bonds. All the mutual funds that invests in purely stocks still beat the STI and some perform dramatically better.
7. As of the time I did this simple research, for 1 year, 2 year, 3 year, 5 year, 10 years… ALLLLLLLLLLLLLLLL of the pure stock mutual funds beat the STI (which tracks only stocks) for ALLLLLLLLLLLLLL time period!
8. There is something I must point out also though. The performances in FundSuperMart do not take into account the initial sales charge of anywhere between 1% to 2.2%. However, we can see that even with the sales charge, most funds will still yield more than STI. For example, over a 30-year period and using the 10-year annualized returns as gauge, taking 5% off $26,196 will still yield significantly more than STI of $6,394 and I used the 10-year worst fund. Yes, I know there are only three funds to make comparisons, but all 3 beat by such a large percentage. Isn’t that alarming?
9. Now… ponder over it… Does ETFs really yield more than Mutual Funds with their lower charges or are you sacrificing one or two percent of sales charge for a few percent in performance? Why do so many articles still say that ETFs beat most Mutual Funds and some claim that they beat 80% of mutual funds? Well… could they have made unreasonable comparisons like comparing the indexes to bond funds? Now… take a minute to process everything and when you are ready, let’s move on again.
10. Finished thinking? Now… I am not saying that Mutual Funds are definitely better for all regions. Maybe for Singapore, the funds are managed better, which explains why they beat the index. I urge everyone to do their due diligence. Let’s assume you believe that a market is going to prosper, perhaps let’s say Malaysia. You may have decided on the region, but cannot decide between ETFs or Mutual Funds. Same thing here… just do the same research and make your own comparisons. Weigh the pros and cons, then make your decision carefully. It is your money! If you don’t care enough to spend time on it to grow it properly, no one will.

I am really glad that you have read this far and it is not to satisfy my ego that what I wrote is interesting. I am just glad that I may have expanded the mind of another individual and did a possible service to his financial well-being. Before I end it all, I want to make another point that may mess up your mind.

ETFs may be way more profitable than Mutual Funds!

Messed up your mind? That is precisely my motive because I feel that decisions are always dependent upon the circumstances and you must adapt accordingly to thrive. Now, why did I make that statement?

One of the advantages of ETFs is no sales charge. This means that some people trade ETFs regularly as if they are day-trading stocks(to buy and sell in a day). For those who are equipped with the proper level of financial literacy, this may be very profitable since markets can fluctuate a few percent points every day. You cannot do the same with Mutual Funds, since the sales charges will rob you of profits. Note however that there are brokerage charges for ETFs too, but they are a lot lesser and dependent on which brokerage you use. Please do not try to daytrade with your own money, unless you have paper-traded (to virtual trade without putting in any money) very successfully for at least a year or so.

Many times, it is a very common mistake to misunderstand a temporary streak of good luck as financial literacy. In good times, the market can be kind to even the worst traders or investors and lead them to think that they are experts in trading. Don’t fall into the trap… make sure that you are well educated in any instruments you deal with and any investment strategies that you execute. Always evaluate the downside too, since the market can catch anyone unawares at times.

If you are not financially literate enough, use the age-old proven strategy… buy-and-hold. It is very difficult to hold an investment for 10 years and lose money. Don’t take my word for it. Check out all the Mutual Funds on FundSuperMart.com and look at the performance for funds over a ten-year period. Only 2 out of 51 funds lost money over this time period. (3 if you take into account the initial sales charge) Of course, past-performance is never indicative of future performance and we should do our due diligence.

My view is that Mutual Funds may continue to perform even better than ETFs. The reason for this is that I am confident in the fund managers that are being produced nowadays. The banking & finance industry has been paying their top staff really well and this has helped lured many smart people to turn to this industry in search of fortunes. The end result is increasing competition for people looking to hop into the direction. I believe that with competition, people grow and it looks like even fresh graduates are equipping themselves with more than just textbook materials.

In short, mutual funds now have a larger pool of people to choose their fund managers. Will this lead to better fund managers? My opinion is that it will, since non-performers can be kicked out easily. It’s stressful for the fund managers, but it is definitely good news for the public.

My final point… Always evaluate investment decisions yourself, since no one cares more about your money than yourself. Books can be wrong, media can be misleading and even Statistics can be based on unfair tests. You are the master of your money and your decisions alone will decide if your portfolio shrinks or grow.

P.S: As you can see… this is my longest post ever. I really hope to gather some opinions off this post. Therefore… if you have the time, tell me what you think. I really appreciate all comments, except comment spam.