The Mutual Fund Deception

The Power Of Compound Interest

The most powerful effect is the nature of compounding. Massive gains only occur near the last few years of several decades of investment. It is vitally important to start investing early in your life to maximize the longest time cycle.

Here is a classic example of compounding:

$100,000 invested @ 8% annual compounded return over 40 years = $2,172,452

The Mutual Fund Deception

One of the greatest value destroyers is the creation of the mutual funds industry by bankers. Investors need to avoid mutual funds due to the nature of its high annual fees and expenses that are hidden from you. Because there are no external charges on your statements (it is deducted before the mutual fund calculate their unit price), you get the false sense of it being free. Nothing could be further from the truth and it is best to illustrate with numbers to drive home the point.

Your typical Canadian mutual fund has an average Management Expense Ratio (MER) of 2.35%. Using the earlier example of an annual compounded return of 8% on a $100,000 investment, here is what the result would be with the inclusion of a recurring MER of 2.35%:

$100,000 @ net 5.65% (8% - 2.35%) annual conpounded return over 40 years = $901,114

This is an astounding difference of over $1.25 million (or -57.5%) of profit that is lost due to the inclusion of a simple MER of 2.35%!

Even a lower fee index fund with 1.1% in recurring expenses calculates to:

$100,000 @ net 6.9% (8% - 1.1%) annual conpounded return over 40 years = $1,442,475

You still lose over $730,000 (or 33.5%) of the profit.

High Fees Erode Wealth

Thus the key take away is that any investment vehicle with an ongoing recurring high fee structure (i.e. expenses exceeding 1%) is guaranteed mathematically to steal most of your wealth indirectly. It is not evident in the initial years when your investment capital is a smaller amount. But in the last five years of the investment life cycle when the miraculous effects of compounding should in theory be working its magic on large 6-digit or 7-digit numbers, the toll of high expenses would have already eroded a significant amount of that wealth that negate the positive impact of compounding.