Fact: Did you know that over your lifetime you might be handing your advisor over half the gains made on your investment portfolio? That means he gains more from looking after your money than you do.
Did he tell you his ultimate cost was more than half your gains?
Did she convince you your cost is some innocuously low percentage?
I ran the numbers and they don’t look good.
The chart below illustrates the gains made on a $10,000 investment that earns 8% annually over the course of 30 years. The blue line illustrates the gains if no fees are charged. The red line incorporates a 1% fee. The yellow line a 2.53% fee.
Why 2.53%? Because that’s the average MER for a Canadian mutual fund.
Given recent fee pressures a 2.53% MER for the average Canadian mutual fund might seem high, but for all the recent talk about fees a huge amount of legacy assets still sits in old-school expensive mutual funds.
The gains earned on the 3 portfolios after 30 years range from a high of $90,627 to a comparatively measly $39,416. That’s a 57% difference! That difference is all owing to fees that go to the consortium of well-suited people investing your money.
Even if you only went from no MER to a 1% MER, you’d still be giving up 27% of your gains.
But doesn’t your advisor earn that money? Not in today’s world. Through any number of online brokers, you can buy a ‘set it and forget it’ portfolio for 0.25%. If you want to get a little more involved, you can build your own portfolio for roughly 0.10%. Not quite ‘no fee’, but close.
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If you’ve been paying attention you probably know that investment fees will reduce the value of your retirement portfolio over time.
For example, Questrade argues that by switching to a lower cost investing platform you could retire 30% richer.
All this is true. Essentially, whatever you pay in fees is foregone wealth. I.e. if your annual fees are 2% and your gross return is 8%, your net return is reduced to 6% after fees.
Remember: fees can be layered (often covertly) into your portfolio in multiple ways – advice fees, investment management fees, tax, operating expenses, and so on. Sometimes the fees are bundled, sometimes they’re charged separately. Buyer beware.
Unfortunately, high fees will do much more damage than leave you ‘less well off’ at retirement. High fees could mean the difference between going broke or not.
Check out the following example for Joe Smith retiring at age 65 with a $1,000,000 portfolio. Sounds like plenty of money for retirement, right? Well, the level of fees mean the difference between Joe eating ham sandwiches and cat food for lunch.
Start with the following assumptions for Joe:
Requires a frugal annual income of $40,000, adjusted for inflation
Will live until age 95
Builds a balanced growth portfolio consisting of 80% stocks and 20% bonds
Has a 10% average tax rate
What are the odds Joe goes broke before he dies?
Calculation methodology for the data geeks: Using data made available by https://engaging-data.com/ , the probabilities are calculated by using stock and bond returns between 1871 and 2016. For example, if an investor expects to be live for 50 years in retirement, all historical 50 year periods are analyzed. One historical cycle would be from 1871 to 1922, another one from 1872 to 1923, and so on until 1965 to 2016. Thus 95 different historical cycles are considered (in this example).
The chart below shows the portfolio failure rate, based on historical precedent, for Joe Smith at various fee levels. “Portfolio failure rate” essentially shows how often during the historical periods the portfolio ran out of money before the end of the period (in Joe’s case 30 years).
Investment fees have a significant impact on the portfolio failure rate. In Joe Smith’s case, the portfolio failure rate rises from 18% when the investment management fee is 0.30% to a whopping 42% when the investment management fee is 2.50%.
Hold up…think about what this really means. Imagine what it would be like to run out of money as a senior citizen.
This is a deadly serious issue and a catastrophic failure of the wealth management industry. The average retiree is getting screwed out of their money leaving them completely broke during retirement. This creates massive hardship, as a broke retiree often has no way of recovering and has to rely on the state, charity or family for food and shelter. Dignity and independence, however, are lost forever.
While the difference between 0.30% to 2.50% sounds very wide, this is the realistic range for investors in Canada.
For example, Cambridge Canadian Equity Fund charges an MER of 2.48%. AGF Global Strategic Balanced Fund charges 2.63%. Mackenzie Canadian Growth Balanced Fund charges 2.29%.
Meanwhile, at the other end of the spectrum, Questrade provides all-in portfolio services for 0.38%. Finally, a DIY investor can combine Vanguard’s FTSE Canada All Cap Index ETF, which has a 0.06% fee and Canadian Aggregate Bond Index ETF, which has a 0.09% fee.
Investors who do a little investigating will better understand their costs and be able to shift from one end of the spectrum to the other.
Bottom line: Pay close attention to fees, as this is one of the few parts of investing that is totally within your control. Over the long run it will have a huge impact to your standard of living and independence.