How to evaluate a mutual fund or ETF before you buy
You don't need to be an expert to judge a fund. Twenty minutes with its Fund Facts or ETF Facts document and one comparison with a simple index fund will tell you most of what matters.
Start with the Fund Facts
Every mutual fund sold in Canada has a short Fund Facts document, and every ETF has an ETF Facts. Download it from the fund company's site and look for:
- What it invests in – the top 10 holdings, the total number of holdings, and the mix by asset type, sector and country.
- How risky it is – a rating from low to high.
- How it has performed – up to 10 calendar years of returns after fees, and the best and worst three-month periods.
- What it costs – the MER, trading expense ratio, trailing commission and any sales charges.
If the fund is described in a way you cannot explain to a friend in two sentences, that is your first warning.
Compare with a benchmark
A fund's return means little on its own. "Up 8% last year" is poor if the market it invests in rose 12%. Pick a benchmark – an index that matches what the fund holds:
- Canadian large-company stocks → a broad Canadian stock index
- US stocks → a broad US index
- Global stocks → a world index
- Canadian bonds → a broad Canadian bond index
- Balanced funds → a mix of the stock and bond indexes in the fund's proportions
The easiest real-world benchmark is a low-cost index ETF that holds the same market. Line up the returns for the same periods (1, 3, 5 and 10 years). If the fund has trailed a cheap index fund over most periods, ask why you would pay more for it.
Look hard at fees
The MER is taken every year, in good years and bad. A 2% fee on a 6% gross return removes a third of your gain; see the 25-year example on the mutual funds page. Compare the fund's MER with similar funds and with index ETFs covering the same market, and check for:
- a lower-cost series of the same fund (for example, one without a trailing commission if you don't use an advisor)
- front-end sales charges, and fees for selling or switching
- short-term trading fees if you sell soon after buying
Risk rating: what it does and doesn't say
The rating (low, low to medium, medium, medium to high, high) is based on how much the fund's value has moved up and down in the past – its volatility. It does not tell you whether the fund suits you, and it says nothing about other risks such as a small number of holdings, use of borrowing, or hard-to-sell investments. Match the fund to your own time horizon and to how you would react to a 20% or 30% drop.
Check for overlap
Owning five funds is not diversification if they all hold the same big banks and tech companies. Compare the top-10 lists of the funds you already own. If the same names keep appearing, you are paying several fees for much the same portfolio. One broad, balanced fund or two or three index ETFs can cover most needs.
Who runs it, and for how long?
For an active fund, a long track record only means something if the same manager or team produced it. Check the management report or the fund's website for the manager's start date. A great 10-year record earned by someone who left last year tells you little. For index funds this matters much less: the job is to follow the index cheaply and closely.
Past performance: use it carefully
- Last year's top funds are often not next year's. A single great year can be luck or a bet that happened to pay off.
- Look at long periods and at the worst year, not just the best.
- Make sure returns are shown after fees (Fund Facts returns are).
- A short record (under 5 years) or a fund that recently changed its strategy or merged with another fund gives you little to judge.
Red flags
Walk away or ask hard questions if you see:
- promises of a "guaranteed" high return, or returns that never seem to go down
- pressure to decide today, or to move your whole RRSP at once
- an investment you cannot find Fund Facts, ETF Facts or a prospectus for
- a seller who is not registered (check on the advisor page)
- fees that are hard to find or that the seller won't put in writing
- advice to borrow to invest without a clear explanation of the risk (see RRSP loans and leverage)
For outright fraud warning signs, see Investment scams.
Checklist
- I have read the Fund Facts or ETF Facts.
- I can explain what the fund holds and why.
- I know the MER and whether it includes a trailing commission.
- I compared returns over 1, 3, 5 and 10 years with a matching index fund.
- The risk rating fits when I need the money.
- It doesn't mostly duplicate funds I already own.
- For an active fund, the same manager produced the track record.
- The person selling it is registered.