[Wealthy1Day]

Hi, first post here. It appears there are some helpful responses on this forum, so I thought I'd join.

I'm glad to say that I started an RRSP sometime ago, but only recently have I become better educated on investing. I'm sold on the couch potato strategy and so I look at a portion of my portfolio under that light, but there are a few actively managed MFs that I've been happy to invest in... my question for you is am I misguided or are the actively managed MFs in my portfolio good decisions?

Here are the funds in my portfolio with their average return and MERs:

Fund Avg Return* MER True Return?
TD Canadian Index 11.4 .31 11.1
TD US Index Currency Neutral 4.4 .48 3.9
TD International Index 3.9 .48 3.4

TD Canadian Equity 12.6 2.07 10.6
TD Dividend Income 9.8 1.92 7.9
TD Dividend Growth 11.0 1.92 9.1
TD Monthly Income 8.8 1.40 7.4

*The Avg Returns are the average calendar returns from 2003 to date as reported on the TD web site.

Question #1: Since the MER is factored into the unit price/market value of each fund (a somewhat hidden cost), am I right to assume that I should look at the real rate of return as being the average reported less MER? Or are the reported rate of returns factoring in MER?

Looking at the 3 index funds alone, they represent 51%, 21%, and 28% respectively. As far as geographic diversification is concerned, this is satisfactory. However, 100% is in equities with 0% in fixed income. (As I'm still fairly young at 32, this is arguably OK)

Now while it's fine to look at a portion of my portfolio as following the couch potato strategy, it becomes moot if I've invested in 4 actively managed funds in addition to the 3 index funds...

When I take my entire portfolio into account, I have about 5% in fixed income (still low, but not zero), but the geographic diversification becomes incredibly weighted in Canadian 81%, US - 8%, and International - 11%.

Looking at the rates of return on these funds, they don't beat the Canadian Index (except for TD Canadian Equity, that is if 12.6% factors in MER), but it appears that I'm lucky to have had the majority of my money in the Canadian market given recent economic events.

Question #2: Although these rates of return reflect a 6 year period (which is significant), this is my RRSP and therefore will be invested for a significantly longer period of time. Should I convert my portfolio to a 100% couch potato strategy? Or are the non-index funds that I've chosen actually decent to hold onto, especially given that they are dividend producing?

I guess my question is, over the long term, is there any benefit investing in these actively managed funds versus a pure couch potato strategy?

A very long post, I know... thanks for reading and thanks for your insight.

 

[DrStan]

Hi, first post here. It appears there are some helpful responses on this forum, so I thought I'd join.

I'm glad to say that I started an RRSP sometime ago, but only recently have I become better educated on investing. I'm sold on the couch potato strategy and so I look at a portion of my portfolio under that light, but there are a few actively managed MFs that I've been happy to invest in... my question for you is am I misguided or are the actively managed MFs in my portfolio good decisions?

Here are the funds in my portfolio with their average return and MERs:

Fund Avg Return* MER True Return?
TD Canadian Index 11.4 .31 11.1
TD US Index Currency Neutral 4.4 .48 3.9
TD International Index 3.9 .48 3.4

TD Canadian Equity 12.6 2.07 10.6
TD Dividend Income 9.8 1.92 7.9
TD Dividend Growth 11.0 1.92 9.1
TD Monthly Income 8.8 1.40 7.4

*The Avg Returns are the average calendar returns from 2003 to date as reported on the TD web site.

Question #1: Since the MER is factored into the unit price/market value of each fund (a somewhat hidden cost), am I right to assume that I should look at the real rate of return as being the average reported less MER? Or are the reported rate of returns factoring in MER?

Looking at the 3 index funds alone, they represent 51%, 21%, and 28% respectively. As far as geographic diversification is concerned, this is satisfactory. However, 100% is in equities with 0% in fixed income. (As I'm still fairly young at 32, this is arguably OK)

Now while it's fine to look at a portion of my portfolio as following the couch potato strategy, it becomes moot if I've invested in 4 actively managed funds in addition to the 3 index funds...

When I take my entire portfolio into account, I have about 5% in fixed income (still low, but not zero), but the geographic diversification becomes incredibly weighted in Canadian 81%, US - 8%, and International - 11%.

Looking at the rates of return on these funds, they don't beat the Canadian Index (except for TD Canadian Equity, that is if 12.6% factors in MER), but it appears that I'm lucky to have had the majority of my money in the Canadian market given recent economic events.

Question #2: Although these rates of return reflect a 6 year period (which is significant), this is my RRSP and therefore will be invested for a significantly longer period of time. Should I convert my portfolio to a 100% couch potato strategy? Or are the non-index funds that I've chosen actually decent to hold onto, especially given that they are dividend producing?

I guess my question is, over the long term, is there any benefit investing in these actively managed funds versus a pure couch potato strategy?

A very long post, I know... thanks for reading and thanks for your insight.

Question 1. Returns and MER
The industry standard for mutual funds is to report all returns after deducting the MER. So the published returns for your funds are post-MER. No need to make additional deductions.

Question 2. Couch potato vs. active management
This is a neverending debate. Funds can beat the index, but few do long term because they are dragged down by fees. There is no way to know that the managed fund you pick will beat the index in the future, but there is 100% certainty that the index fund you pick will provide results very similar to the index. It won't beat it, however. With all the ups and downs, and considering your long investing timeframe at age 32, I would consider selecting a few index funds as core holdings (perhaps making up 75% of your portfolio). If you feel the need to diversify, then go ahead and select a couple of managed funds to round out your portfolio (precious metals, emerging markets, etc.)

Are you saying you own all four of the managed funds you mention, plus the three index funds? It's not clear from your post. There's no way I would hold more than one of the four managed funds; not only are their main holdings very similar, but they are also very similar to the holdings of the TD Canadian Index fund which you already own. This is a common problem -- redundancy in the same portfolio. You are essentially paying a higher "managed" MER for the same holdings as your index fund.

Always look at things in the long run. I believe buying and holding a good core index portfolio will give you stronger results than the majority of investors out there. That still leaves room for managed money, but as a diversification tool, not as a redundancy as in the funds you mention!

The classic portfolio is something like 25% in each of the Canadian, U.S. and International funds, plus another 25% in fixed income. You can choose to underweight some sectors and overweight others to match your preferences.

Good luck!

 

[CanadianCapitalist]

I have no doubt that some funds will beat the index. The trouble is picking these funds in advance. Also, the longer the time horizon is, the lower the odds that an active fund held for that period of time will beat the index fund.

 

[leslie]

1) Stop relying on published returns for your own holdings. Start keeping track yourself. There are piles of evidence that actual human being's returns are much lower than the published returns because of the timing of their additions/draws, reinvestment of dividends etc.

2) Yes, the MER is already included in the published past results. It becomes important when considering future probable returns. If you accept that regardless of a past winning streak, the probability of beating the market NEXT year is still only 50%, then you should expect to underperform the market by the amount of the MER. Long-term mutual funds have shown this to be true. On average funds earn the index return LESS the MER.

3) In the debate whether active investment can beat passive indexing,

(i) a big part of the research problem lies in the use of mutual funds' returns as the 'proof'. Yet many funds are REQUIRED to stay fully invested, and prohibited from shorting the market. So in the last year's downdraft, even if they wanted to exit the market, they couldn't.

Add to that the fact that some investors bought mutual funds with deferred sales charges, and so cannot sell their fund without huge penalties. Thus they are locked in (twice over) through down drafts.

This has the effect of making the returns from active mutual funds much lower than the manager probably earned on his own invested money.

(ii) a proven problem for mutual fund managers comes from excessive cash flows - into the fund after it has done well and out of the fund after poor performance. These fund are very hard to deal with - forcing him to buy and sell at NOT opportune times. And lowering his returns.

CONCLUSION: I believe that active management can outperform the market, or at least match the market with lower risk (which is what I accomplish). But that active mutual funds have headwinds (in addition to their actual investing performance) that make it impossible except for short, lucky, periods of time.

 

[Wealthy1Day]

Question 1. Returns and MER
The industry standard for mutual funds is to report all returns after deducting the MER. So the published returns for your funds are post-MER. No need to make additional deductions.

That clears things up - thank you very much! So I never really need to take MER into account when looking at the performance of a fund. I just need to take it into consideration when making a decision between two or more funds.

So it looks like the TD Canadian Equity fund has beat the TD Canadian Index fund taking MER into account. Nevertheless, that's only over a 6 year period and I'm looking at another 30.

Are you saying you own all four of the managed funds you mention, plus the three index funds? It's not clear from your post. There's no way I would hold more than one of the four managed funds; not only are their main holdings very similar, but they are also very similar to the holdings of the TD Canadian Index fund which you already own. This is a common problem -- redundancy in the same portfolio. You are essentially paying a higher "managed" MER for the same holdings as your index fund.

Yes, I own all four plus the three index funds. Essentially, I had those four managed funds before adopting the couch potato strategy and have kept them in my portfolio. I adopted the couch potato strategy with new money to invest upon becoming more educated about investing. So the redundancy in my portfolio has arose as a result of adopting the couch potato strategy. To eliminate the redundancy, I would need to take your advice and switch the managed funds into funds that follow the couch potato strategy.

Always look at things in the long run. I believe buying and holding a good core index portfolio will give you stronger results than the majority of investors out there. That still leaves room for managed money, but as a diversification tool, not as a redundancy as in the funds you mention!

Even though the Canadian Equity fund has outpaced the Index fund in recent years, I'm looking at this very long term and so it may be a better approach to switch fully to Index. That way the higher cost doesn't need to be a consideration when reviewing my RRSP. More conservative, but perhaps the better way to go for the long term.

The classic portfolio is something like 25% in each of the Canadian, U.S. and International funds, plus another 25% in fixed income. You can choose to underweight some sectors and overweight others to match your preferences.

With the way things have been lately, I'm glad the majority of my holdings have been Canadian. But over the long term, it may benefit me to be better diversified geographically. I'll still go underweight in bonds for now I think.

 

[Robillard]

Tracking one's own investment performance can be rather tricky, especially when one is making regular contributions and dollar cost-averaging. Ideally the best way to determine one's return would be to solve for the interest rate that equates the future value of the stream of annuity payments (the amounts you invested on a regular basis) with the current market value of the investment or portfolio.

Mathematically, this could be represented by:

MV = P * FVA(i,m,t)

"MV" is the market value of the portfolio or investment at a given time.
"P" is the regular amount of investment (assuming that it is fixed and at regular intervals).
"FVA(i,m,t)" is the future value of an annuity; it is a function of "i", the interest rate or annual rate of return; "m", the number of compound periods per year; and "t", the number of years.

Unless you have a mathematical software package, solving for "i", the annual rate of return, can be best done through trial and error. I don't know if anyone actually uses this approach, but it is theoretically sound.

 

[Wealthy1Day]

This is good discussion on how to properly calculate rate of return.

I should mention that the use of published rates was for example purposes in determining whether MER is factored in or not. The rates used are irrelevant to determine the answer to the question.

Obviously, personal performance isn't going to be based on published calendar RORs.