I often talk about stock market returns in this column. This has some readers wondering why their investments seem to be lagging.
“I may be unlucky, but since I started investing in 2018 in fairly standard growth mutual funds, my annual return is around 2% after 5 years, writes Benjamin. What kind of returns can we expect in the future? »
Benjamin’s message made me do a little math: the Toronto Stock Exchange has had annual returns of 6.61%, including the reinvestment of dividends, since 2018. On the American stock market, the growth of the S&P 500 was 9.33% per year on average over the same period.
So why doesn’t Benjamin, who makes weekly payments and invests with a growth objective, get richer faster?
I think now is a good time to talk about best practices in stock market investing.
As the title of this section states, I do not hold any stocks in my portfolio. Yet I invest in thousands of publicly traded companies and essentially get market returns.
How is it possible ? By buying not stocks, but exchange-traded funds (ETFs).
If every publicly traded company was a meal, ETFs would be like buffets. These funds contain the shares of hundreds, if not thousands, of companies. By buying a unit of ETFs, one automatically becomes a co-owner of these companies.
By far the most popular ETFs are index ETFs, that is, those that aggregate the stocks of a given stock market. In Canada, these are ETFs that replicate the S&P/TSX index, which represents the 250 largest companies listed on the Toronto Stock Exchange.
In the world, the largest index ETFs are those that replicate the 500 largest companies trading in the United States, the S&P 500 index.
By buying index ETFs offered by companies like RBC iShares, BMO or Vanguard, to name only the three largest players in the country, you can therefore have the entire stock market – thousands of companies around the world – in the palm of his hand.
Many critics of index ETFs rightly say that by owning the market, you can’t beat market returns. They often recommend that we invest in mutual funds, also called mutual funds, whose content is chosen individually by a manager and his team – that’s what Benjamin did.
Trying to beat market returns is a laudable ambition. Unfortunately, S&P Global has calculated that over the long term, less than one in ten fund managers do well, and a manager who does well in one year is not necessarily the same one who will do well the next.
So long-term market growth is happening, but the majority of funds are not fully capturing it.
In addition to the difficulty of beating the market, active investing usually comes with high management fees. It’s not uncommon to pay 2% of your portfolio size annually for an actively managed portfolio, which includes management and operating fees, acquisition fees and operating expenses, among others.
Saying goodbye to 2% of our assets every 12 months has a significant eroding effect over time. It’s a bit like trying to run a marathon with ski boots on. Index ETFs generally have management fees of 0.25% or less.
Also, many managers say that mutual funds are less risky than ETFs because they are less volatile. A 2016 study by S&P Global showed that the actively managed portfolios that fall the least in stock market storms are simply those with the most cash. In short, nothing really magical under the hood.
One of the lesser-understood benefits of ETFs is that “merely” getting market returns doesn’t make us average investors: it puts us in the top tier of the world’s best investors.
For 50 years, a balanced and diversified portfolio made up of 60% Canadian, American and international index ETFs and 40% ETFs that track government bonds has grown by an average of 8.8% per year.
$1,000 theoretically invested this way 50 years ago would be worth $68,000 today.
Since 2018, Benjamin would have made 5.5% annual returns with such a balanced portfolio. With 20% bonds instead of 40%, so a more growth-oriented portfolio, he would have made 7.5% per year.
In Canada, 13% of investments are held in ETFs, while more than 50% are in the United States. Why ? Because the competition is stronger in the United States, and low-cost solutions have prevailed. Here, the less dynamic market is slowing down this transition.
Yet the transition is happening: as of November, Canadian ETFs had seen inflows totaling $35 billion in 2022, while mutual funds had seen outflows of $35 billion, according to National Bank Markets. financial.
I feel that many finance professionals do not like what they read in this text, and are burning to launch Outlook to wish me a happy new year. If this is your case, let me reassure you: I don’t recommend that most people open a brokerage account and buy ETFs themselves.
Why ? Simply because managing large sums of money yourself can be daunting and not to everyone’s taste. And poor investor behavior (selling during a stock market storm, stopping investing until we “let the storm pass”, investing too little, etc.) can cause us to lose a lot more than 2% a year.
Fortunately, more and more professionals are choosing to offer index ETFs to their clients. Instead of the usual 2%, they pay around 1% in annual fees, while benefiting from financial planning and support services.
Paying 1% isn’t ideal, but it’s certainly better than paying double that. It is a step in the right direction.
“Investors big and small should stick with low-cost index funds,” Warren Buffett wrote in his 2016 letter to shareholders.
When the Oracle speaks, I listen.