Much to the chagrin of us here at Motley Fool Canada, the majority of Canadians continue to plough their hard-earned wealth into expensive mutual funds.

The average fund in Canada has an annual management fee of approximately 2.5%, a number that looks pretty reasonable on the surface. But in reality it’s a huge bite of an investor’s wealth each year. With the stock market only expected to return in the neighborhood of 8-9% annually, taking away 2.5% each year is a pretty serious handicap.

Look at it this way. If you invested $50,000 at a 9% return, you’d end up with a pretty impressive nest egg of $663,383 at the end of 30 years, assuming no taxes or other fees. If we ratchet the return expectations down 2.5% to 6.5% annually, the same $50,000 original investment grows to just $330,718.

I don’t know about you, but I certainly can’t afford to lose $330,000 over the course of my investing career. That’s the difference between a comfortable retirement and one where someone is constantly pinching every penny.

Plus, it’s not like alternatives don’t exist. Canadians looking for information about individual stocks can easily find what they’re looking for, and learning how to invest is a skill I’m convinced anyone can master if they dedicate some time to it. And if not, exchange traded funds (ETFs) offer all the diversification that a mutual fund boasts with a management fee that’s only a fraction of what mutual funds charge.

Investors can buy an ETF that tracks the TSX Composite Index for a management fee of 0.05% per year. To put that into context, that’s 98% less than the typical mutual fund fee of 2.5%. It’s pretty obvious that mutual fund investors would be better off in a low-cost ETF like the iShares S&P TSX Capped Cmpst Indx Fnd (TSX:XIC).

In 2016 the number of Canadians invested in mutual funds could head sharply lower. Legislation has been passed that will force mutual fund companies to disclose to investors what their mutual funds will cost to own in dollar terms, not just percentage terms. Suddenly, investors will be hit with the reality that a 2.5% fee on $100,000 in assets is $2,500 per year.

How will this affect Canada’s fund companies?

Why I’m bearish on mutual fund providers

When I think of mutual fund companies in Canada, three immediately come to mind: IGM Financial Inc. (TSX:IGM), AGF Management Limited (TSX:AGF.B), and CI Financial Corp. (TSX:CIX).

IGM Financial is best known for its Investors Group subsidiary, an army of some 5,000 investment advisors with offices located from coast to coast. Investors Group reps tend to make a pretty good living on recommending products like insurance, mortgages, and, of course, expensive mutual funds.

Investors are well aware this new legislation could cut into IGM’s bottom line, and have responded by sending the stock much lower. At the current price of less than $35 per share, IGM trades at just 11.4 times earnings and boasts a dividend yield of 6.4%. And that’s before the disclosure changes become mandatory.

The basis of IGM’s whole business model rests on providing investors with expensive funds. Once investors start avoiding mutual funds en masse, who knows what it’ll do to IGM’s bottom line.

Perhaps AGF is an even more precarious spot though. AGF doesn’t have an army of sales reps to push its products; rather, it’s forced to use independent mutual fund agents as a way to sell its funds. That’s a tough go even when the market is good. It’ll be even tougher in a future with better disclosure.

CI Financial is the star of the sector, but even it’s seeing some pretty serious weakness. Shares are currently at a 52-week low, and the dividend yield has been pushed up to 4.4%. Shares trade at 15.2 times earnings, which is the most expensive of the three peers. CI has also been hit recently with declining assets under management.

There may be a point where these stocks are attractive to value investors. But until we see just how the new disclosure rules will affect assets under management, I think investors should stay away from Canada’s mutual fund companies, whether through investing in their stocks or their expensive funds.

The better way to invest in wealth management... the banks!

It may sound funny after reading that article, but I'm bullish on money management in general. Just not through expensive funds. It's obvious Canada's largest banks will capture the lion's share of that upcoming boom.

That's not the only reason investors should load up on Canada's banks. After all, they're very stable, well capitalized, and face limited competition. That said, there are concerns for the banks and their investors. In this FREE report, we cover everything you need to know about Canada's Big Five--whether you're already an investor or are considering buying shares. Simply click here to receive your special FREE report, "What Every Bank Shareholder MUST Know."


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Fool contributor Nelson Smith has no position in any stocks mentioned.