You finally have some savings — money you can afford not to touch until 65, or 70 or whenever retirement will be. Let’s say the funds are between $5,000 and $10,000 — not much, but certainly worth investing and growing. What should you do with that money?
If you’re looking for something simple with low fees and decent, long-term average returns, there are three main options: index mutual funds, all-in-one exchange-traded funds (ETFs) and robo advisors. But which one is best?
Global News put that question to Darryl Brown, independent financial adviser at You&Yours Financial, and Benjamin Felix, portfolio manager at PWL Capital.
Here’s what they had to say.
Index funds
What we’re talking about:
An index fund is a mutual fund that holds or tracks all or almost all the components of a financial market index like the S&P 500. The idea is to reproduce the returns of the overall market instead of having a portfolio manager actively pick investments to try to beat the market. Why settle for market returns instead of aiming higher? One reason is that plenty of research shows pegging your fortunes to the ups and downs of a broad-based financial market index yields higher average returns in the long term than putting your money into the hands of a human choosing investments for you. The second reason is that setting your investments on autopilot allows for lower fees.
READ MORE: How much do you really need for retirement? We did the math
Pros:
Pretty low fees: Mutual funds typically come with all sorts of fees. Management fees and operating expenses, in particular, can be hard to track because they are paid by the fund. The management expense ratio (MER) measures how much of the fund’s assets went to pay these administrative costs.
While there’s no money coming directly out of your pocket, these operating expenses reduce the fund’s assets and, therefore, your own returns as an investor. MERs can range from one per cent to three per cent, which eats a chunk of investors’ returns over the long term. For example, an investment of $10,000 earning six per cent per year would go to $43,000 over 25 years with no fees. With a three per cent MER, though, you’d have just under $21,000 at the end of the period, with almost $22,000 worth of potential returns lost because of fees.
The good news is that index mutual funds have much lower fees. The TD e-Series funds, for example, have MERs as low as 0.33 per cent and no transaction fees when you buy the funds. With an MER of 0.33 per cent, your $10,000 would grow to just under $30,000 over 25 years.
User-friendly: One of the advantages of index funds is simplicity, Brown said. You can purchase them through a sales agent at the bank or place the order yourself online through a usually user-friendly interface, he noted.
Easy to make regular contributions: Another plus is that making regular contributions to your account is easy and free with index funds, Brown said.
READ MORE: The ‘wealth formula’ — Bay Street insider has two simple rules for making money
Cons:
Not the lowest fees: While index funds have much lower fees than actively managed funds, you’ll save even more with ETFs.
All-in-one exchange-traded funds
What we’re talking about: Most ETFs also track a specific financial market index, but unlike index funds, they are bought or sold on an exchange like stocks. There are all kinds of ETFs out there tracking all sorts of things, but all-in-one ETFs are one of the major recent innovations in this space.
All-in-one ETFs are collections of ETFs that offer investors exposure to Canadian, U.S. and international markets. This means you can put all your money in a single ETF and still have your eggs in lots of different baskets, which reduces risk.
Most all-in-one ETFs come with a certain split between stocks, which are prone to ups and downs but tend to deliver higher returns over the long term, and bonds, which are less volatile but also yield lower returns. For example, at Vanguard, which pioneered this kind of ETF, the range goes from 80 per cent bonds and 20 per cent stocks to 100 per cent stocks. The main choice you have to make as an investor is picking the right mix of stocks and bonds based on your goals, investment horizon and risk tolerance.
And here’s the kicker: you don’t have to worry about realigning your portfolio to maintain their desired value split among different types of assets despite price fluctuations. All-in-one ETFs rebalance automatically, which means all you have to do is hold your investment and wait for returns.
READ MORE: All-in-one ETFs — why you may be fine buying a single investment and holding it until retirement
Pros:
Super low fees: Low fees have always been the key strength of ETFs, and all-in-one ETFs are no different. The Vanguard funds, for example, charge a low management fee of just 0.22 per cent.
Super easy in some ways: ETF investing used to mean having to choose funds for your portfolio and tinkering with them to rebalance your investments on a regular basis. All-in-one ETFs, though, offer the ultimate set-it-and-forget-it investment options.
READ MORE: Here’s what fees can do to your retirement if you don’t pay attention
Cons:
Not so user-friendly: The idea of buying a single investment and holding it for years sounds as easy as investing can be. But buying ETFs isn’t so simple, Brown said. That requires setting up an account with an online broker, which won’t necessarily have a user-friendly interface, he added. And buying an ETF is like buying a stock: you need to know the ticker and calculate how many units you can afford to buy.
“It’s intimidating,” Brown said.
Leftover cash: You may not be able to invest all your money and be left with a little leftover cash that isn’t enough to buy an additional unit. Though this probably won’t matter much even with a small portfolio, those are still funds that aren’t earning interest.
Making regular contributions can be expensive and inconvenient: Making regular contributions to your account can be a minor headache if you have a small portfolio invested in ETFs, Felix said.
One issue is that if you’re only saving, say, $50 a month, you have to wait a few months before you have enough to buy additional units.
“It’s going to be awkward amounts that you get to buy so you have to buy twice per quarter or once a year,” Felix said.
Another issue is that you can only trade ETFs when the stock market is open, which tends to coincide with when most people are at work.
“If you’re young and super busy, it can be a hassle,” Felix said.
Also, you often have to pay a fee — usually between $9 and $10 — to buy additional ETFs. Spending $100 to $120 in trading fees per year doesn’t matter too much when you’re investing $500,000 and saving in MERs, which are a percentage of your invested assets. But the math is less favourable if all you’re investing is $5,000. However, Felix noted that some online brokers, like Questrade, have eliminated the problem by charging zero fees when you buy ETFs.
The temptation to trade: Another issue is that once you’ve learned how to trade a stock, you may be tempted to tinker with your portfolio instead of just buying and holding a single fund, both Felix and Brown said.
WATCH: All-in-one ETFs, a new and cheaper option for growing your savings
Robo advisors
What we’re talking about: A robo advisor is an online service that professionally invests your money for fees that are often less than half what the banks or investment managing firms charge. Robo advisors usually use portfolios made up of inexpensive ETFs.
When you sign up with a robo advisor, you usually have to answer an online questionnaire about things like your financial goals and how nervous you get when the stock market goes down. The robo-advisor firm will then invest your funds based on your personal profile and risk tolerance.
READ MORE: Robot vs. human: When you should invest with robo advisors
Pros:
Super user-friendly: Like index funds, robo advisors have very user-friendly interfaces.
Easy to make regular contributions: Also like index funds, robo advisors are fully equipped to accept and invest automatic contributions.
WATCH: Should you invest with a robo advisor?
Cons:
Not the lowest-cost option: You’re a paying fee to the robo advisor itself in addition to the underlying fees tied to the ETFs in your portfolio. Wealthsimple, for example, charges 0.5 per cent in addition to around 0.2 per cent for the underlying ETFs.
But with just $5,000 invested, the additional 0.5 per cent fee would work out to just $25 a year, Felix noted.
Wealthsimple lowers its fee to 0.4 per cent for clients with portfolios of at least $100,000. While that’s a lower percentage, it means paying at least $400 a year in fees you wouldn’t have if you were investing on your own in ETFs, Felix noted.
On the other hand, Wealthsimple also offers premium services like financial planning for portfolios of $100,000 or more.
If the quality of those added services is good, the added fee may be worth it, according to Felix.
“Four hundred dollars a year for access to financial planning advice is actually a pretty good deal,” he said.
WATCH: Investing with robo advisors during recessions
The bottom line
With a small investment, all three options are solid, both Brown and Felix said. The important thing is to start investing and choose something you’re comfortable with, Brown said.
But as your portfolio grows so will what you’re paying in fees, Felix noted. What works well at $5,000 may not be the best option at $100,000.