How a 2% fee adds up to $350,000 over time?
Author:Adam Mayers/ You ignore investing fees at your peril. The longer they add up, the worse it is for you, costing tens of thousands over the life of your investments.
Who wouldn’t walk a mile for a 50 per cent off sale at their favourite store? But in the world of investing you should be banging down the doors to cut your fees by 1 per cent.
In the world of investing, cheap is good.
Sure, most of us would jump at a 50-per-cent off sale at our favourite store. Who wouldn’t choose a BMW over a Kia to get the performance and comfort of a luxury ride?
But when it comes to money management that’s exactly what you don’t want. Forget the Beemer. Take a bike. Better yet, walk. Don’t go for 50 per cent off — cut your fees by just 1 or 2 per cent and you’re set for life.
One of the biggest obstacles to investment success is fees, but readers don’t want to know about it. Write about fees and you’ve got the unread story of the day. It’s part inertia and part lack of interest (who cares about 1 per cent?), part lack of confidence (I’ll seem dumb if I can’t do the math) and part a sense that managing money is a job for pros (not true.)
It’s also because we love big numbers. We’re trained to think 50 per cent off a pair of shoes is big deal, but a 1 percentage point cut in the cost of managing our money is no deal at all.
A small graphic buried on page 300 of the pre-election Ontario budget documents shows how costly that thinking is.
The chart is the clearest and simplest expression of why you ignore investing fees at your peril. The longer these little fees add up, the worse it is for you and your lifestyle in retirement. The longer you fail to pay attention and let someone else do the work for you, the more of your hard-earned savings are diverted into another pocket.
The chart shows what happens if you invest $6,000 a year for 40 years in a registered retirement savings plan. It assumes your RRSP earns a little over 5 per cent a year and ignores taxes.
In a utopian fee-free world, your money is worth $785,000 in 40 years.
In a 1-per-cent fee world, you’ll have $606,000 — 23 per cent less.
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It seems odd that such a small amount could make such a big difference. But here’s why. If you invest $100 and the fee to manage your money is 2 per cent a year, it costs $2. Suppose your profit is 5 per cent, or $5 a year. The $5 profit minus the fee leaves you with $3, which is 40 per cent less.
Over the years, the power of compounding works against you and you lose $350,000 in the 40-year span. Who got that money? Your adviser, his company, maybe a bank or fund manager and all the other players in the investment industry who take a slice of your savings.
Charles Ellis, an American money manager who at one time sat on Yale University’s investment committee, wrote an investing book called Winning the Loser’s Game. He says when fees are stated as a percentage of assets they look low, just a dollar or two per $100. But you already own the asset — the $100 — so why should you pay a fee on that? The better way, to look at fees, he says, is as a percentage of returns.
Exchange traded funds (ETFs) are the closest you get to a no-fee world, what Ellis calls the index-investing alternative. For the most part, ETF fees for simple indexes are between 0.05 per cent and 0.40 per cent, according to Yves Rebetez, a former Royal Bank portfolio adviser, who now runs ETF Insights, a website about all things ETF. Those fees compare to 1.5 and 3.5 per cent for mutual funds.
ETFs are lower cost because they buy indexes made up of stocks, not the stocks themselves. So they avoid the buying and selling of actual shares as mutual funds do, which triggers commissions and taxes. The worst an ETF can do is the average return, which for all stocks is about 7 per cent a year over time.
Rebetez says many Canadians don’t appreciate that investing is about small numbers, not big ones.
“We’d go to Walmart to save 50 per cent, but frankly nobody cares about 1 per cent. I also think many people are intimidated and feel incompetent,” he says. “They don’t understand that indexes provide the biggest free lunch of their lives.”
If you’re happy with your adviser, or the performance of your mutual funds and the fees offer value for service, that’s great. Stick with it.
If not, take some time to compare products and fees. Basic information about exchange traded funds is readily available. Rebetez’ site has resources as do the banks and ETF providers. A Google search of “what is an ETF?” will take you to dozens of sources.
It’s time well spent if it cuts your fees by just 1 per cent.
Jun 01 2014
