Balanced Mutual Funds should be illegal


I suppose that is a bold statement but once you understand the logic behind it you’ll probably agree. A Balanced fund is nothing more than a fund that invests in equities and fixed income all in one mandate – in order to reduce volatility. But the problem is the fees of balanced funds are usually anything  BUT balanced.  In addition perhaps a fund company might have great equity managers but less than stellar fixed income managers (or vice versa).

Mutual_fund.jpgLet me start by dissecting the fee dilemma. Generally speaking, the management fees of a mutual fund are directly correlated with the degree of time, research and ongoing monitoring that a fund requires. So for example, a bond fund is comparatively easier to manage and monitor than an equity fund – hence the management fees are on the lower end of the spectrum. Equity funds on the other hand tend to require much more of a fund company’s resources and accordingly have higher Management Expense Ratios (MER’s). To take it even further, foreign equity funds have even higher MER’s still (up around 3.5% in some cases) since the fund company may require offices in those foreign markets, and the trading costs for those foreign exchanges may be higher.

A balanced fund is merely a blend of equities and fixed income – for the sake of this argument, let’s call it 60% equities and 40% fixed income. What I’m arguing, is that you should just go out and buy a pure equity fund for 60% of your portfolio and a pure fixed income fund for 40% of your portfolio.

Balanced funds in Canada tend to have MER’s closer to that of pure equity funds, so let’s draw up an example to see why choosing individual pure funds might be better from a cost point of view. Let’s say that our Pure Equity Fund has an MER of 2.70%, our Balanced Fund has an MER of 2.45% and our Fixed Income Fund has an MER of 1.20%.

We know that to replicate the Balanced Fund’s asset allocation we just need to put 60% of our money into the Pure Equity Fund and 40% into the Pure Fixed Income fund. If we calculate the weighted-average MER, it would look something like this:

60% x 2.70% MER + 40% x 1.20% MER = 2.10% Weighted-Average MER

So as you can see, the exact same portfolio would be cheaper by 0.35% in this case (2.45% versus 2.10%) – and while that may not seem like a big amount, consider that on a $500,000 portfolio that is an annual savings of $1,750. I don’t care how much money you have, if you have two identical items why on earth would you be happy paying more than you have to?

The other argument for buying the pure underlying mandates in separate funds is that you are no longer tied to the manager of only one firm for your overall portfolio. Quite simply, some fund companies are known for the equity fund performance and some are known as fixed income specialists – it’s pretty rare to find a company that is #1 in both respects – especially considering there are now 1,994 mutual funds to choose from in Canada according to the Investment Funds Institute of Canada!

Are you investing in a Balanced Fund? It might be time to take a look at your MER and see if you can save some FREE MONEY! :) 

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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