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Couch Potato Strategy, True Rate of Return?, Non-Index Funds

7568 Views 6 Replies 5 Participants Last post by  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.
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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.
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