The Eternal Question: To Pay or Not To Pay Fees?
This is basically what Paul asked on How I Beat The Market With My Trades. He mentioned that he owns shares of the popular BMO Monthly Income Fund. While I’ve already analyzed this fund, I wanted to add more thoughts on why you should or shouldn’t buy indexes or mutual funds instead of trading your own stocks.
I’ll tell you upfront, I think that investing in dividend stocks, ETFs and mutual funds are all great investing techniques…
Say what?
Ok… I cheated I didn’t finish my sentence: “… depending on which kind of investor you are”.
So let‘s start with the most controversial investment product; the hated mutual fund
What’s wrong with you people that are paying fees? Are you all dumb? In fact, I don’t think you are! Mutual funds can be great since they are:
– Managed by professionals
– Allow you to buy multiple stocks without trading fees
– Managed and rebalanced without you doing anything
– Committed to their investment strategy and asset allocation mandate
So when you look at it this way, it’s not that bad. What’s the problem with mutual funds? Nothing but 3 letters:
M
E
R
!
I think that if you are able to build a portfolio with mutual funds and pay less than 1.50% in MER, you are in a good position. It will require less time from you and you will still be able to make a decent amount of money. However, the problem is that most of the time, you have to pay way more than 1% or 1.5% to have more than 50% of your portfolio in stocks.
The other thing that you need to look at is front end loads and back end fees (buying and selling transactions fees). Some of them (not to mention Investor’s Group), are pretty good at holding on to the client for 7 years with huge penalty fees if you sell before this period. This is why it is important to be careful about fees before investing in any mutual funds.
Mutual Fund Investor Profile
– Doesn’t know much about investing and doesn’t want to learn.
– Doesn’t want to spend too much time on his investments.
– Wants to save more on transaction fees than on management fees.
– Doesn’t want to rebalance, buy & sell stocks in its portfolio.
Low fees, easy to trade: here comes the ETF
The most popular way to investing these days (thx to Vanguard!) is ETF investing. In fact, with very low cash and limited time, you can easily build a solid portfolio. And if you want to simply cross reference your index with its 200 days moving average, you can even take a shot at beating the market!
Several investors like ETFs as they basically help them to track what they want. More general investors will simply buy a few indexes through ETFs and apply a “coach potato” management style. You can see this series on ETFs asset allocation for more details.
I’d say that ETFs are wonderful for investors who want to pick up a specific niche or index. For example, I bought a covered call ETF in order to track the Canadian banks (ZWB). On the other hand, the main problem of ETFs is its infinite diversification possibilities and the ability to use leverage through them. This side of ETFs make them a weapon of mass destruction when not used properly!
ETF Investor Profile:
– Is knowledgeable and understands how the stock market works.
– Can manage his asset allocation properly and build a portfolio.
– Doesn’t like management fees (MER) and would rather pay a low transaction fee.
– Is willing to rebalance the portfolio once or twice a year.
– Have a little bit more time to manage his portfolio (can still do it “coach potato style”).
And finally, Dividend Stocks portfolio
As you can see in my dividend holdings, I’m a stock picker. I’ve always been aggressive in my trades and I decided early in 2011 to switch to a dividend investing mode. This was actually a very good choice as I’m making more money this year with my dividend stocks than my speculative picks!
I like picking my stocks as I feel “in control” and I love receiving monthly dividend payouts in my brokerage account! I think that if you make the right dividend picks, you can eventually earn a 6 to 7% dividend payout (read more about the power of dividend growth). So if I use the next 30 years to build my portfolio, I will likely be able to live off my dividends and barely touch my capital. This is the model I want to build over time.
However, stock picking requires more time than mutual fund and ETF investing. While some may spend several hours on building their ETF portfolio, there is always a smoother way to do it (just buy 3-4 indexes and you are done). When you are picking your stocks, you have to consider several factors as each stock will affect your asset allocation and its diversification. If one buys only financials or utilities, he will be greatly dependent on this sector.
The chances of making mistakes are also greater. You won’t benefit from any professional support (as opposed to mutual funds or ETFs). With dividend stock investing, you are definitely on your own. If you are on a journey to chase high yields, you may end-up losing a lot of money.
Dividend Stock Investor Profile:
– Is analytical and loves to take the time to look at each stock.
– Wants to save on both MERs and Trading fees.
– Wants to build his own portfolio, manage his own asset allocation.
– Loves rebalancing, buying and selling shares.
– Has good investment knowledge and won’t panic when markets drop.
Why wouldn’t you combine all of them?
My friend and partner in my online company is not totally convinced that a 100% dividend stock portfolio is a good thing and he thinks that adding a few indexes (through ETFs) can provide both more growth and a better diversification.
The previous owner of this blog (until 2010) was also a great believer in building a core with ETFs and adding growing dividend payers around it to provide more income. I like this technique as well but consider that you need a sizable portfolio to do it. For example, it’s hard to invest in 5 ETFs and add a dozen dividend stocks if you only have 20K to invest!
Sometimes I actually combine both dividend stocks with mutual funds. I’ve chosen index mutual funds as I want to save on trading fees since I usually “park” $500 to $2000 and it’s only while I find another dividend stock to buy. In my opinion, I think that mixing investment products can be a very good idea for most investors as you can definitely get a better diversification. But when it comes down to my portfolio… I really like to own stocks!
How do you manage your portfolio? Do you pick only stocks or do you use a combination?
I took a “horse race” approach to investing a while back. I created one group of investments that were structured as a “couch potato” blend of broad index mutual funds, and then also began building a portfolio of individual dividend stocks. Both have done well, but there is just something about that feeling of seeing dividends come in every month that makes me feel so good.
@Jon,
I think this is the main reason why people like dividend; while you see your capital fluctuating, you can always rely on a cash payment in your brokerage account from time to time. This makes you wait longer before pressing the panic button!
Nice post!
I used a blend of strategies, indexing and dividend-investing. I get the best of both worlds this way!
Will definitely include this post in my weekend reading!