Why you should care about your Investment Costs

by Invisor Last updated on February 20, 2015 Tags: Save Well

If you hold Mutual Funds in your investment portfolio, you must read on.

Mutual Funds are very effective investment products for most investors seeking to hold a diversified portfolio. However, the costs associated with investing in mutual funds, in general, have remained very high in Canada. A 2013 Morningstar report titled “Global Fund Investor Experience” indicated that Canada has one of the highest investment costs for mutual funds amongst 24 countries covered in the report.

The table below shows the top 10 mutual funds by size (total assets) in Canada and the average returns they have realized over time vs. their Management Expense Ratios (MER). The MER-Performance Ratio included in the table measures the fund’s MER as a percentage of the fund’s estimated gross long-term performance using the longest available comparable performance history for all the funds. This ratio indicates how much of the fund’s annual total return you give up to pay for your investment costs of holding the fund. Remember, you incur the MER no matter how the fund performs in any given year, including in years with negative performance.

Negative PerformanceSource: Morningstar. Numbers in the table are as at the end of January 2015. MER-Performance Ratio is calculated by Invisor.

Furthermore, here is a table that show some of the larger mutual funds in Canada (by Total Assets), which have an MER (cost) of over 2.50% per year (exorbitant, in our opinion!).

Mutual FundsSource: Morningstar. Numbers in the table are as at the end of January 2015. MER-Performance Ratio is calculated by Invisor.

There are many such funds in Canada today with an MER of well over 2.5% per year. The question is do you really have to pay so much? Is there sufficient value that you derive from holding these funds that justify the costs?

So why does cost matter?
Keep in mind that we are in a persistently modest-growth, modest-return economic environment, which is expected to continue in the foreseeable future. In this environment, if you are paying over 2% in investment related costs per year, you may well be giving up 25 to 50% of your annual return to pay for such costs.

To put that opportunity cost into perspective, if you have $50,000 in your RRSP portfolio today and commit to saving $10,000 every year over the next 25 years towards your retirement goal, a 1 percentage point investment cost saved on an annual basis results in an incremental portfolio value of about $120,000 when you retire (assuming your portfolio earns an annualized gross return of 7% over the time period).

This is the power of compounding (check it out here) that can make a huge difference for you when you start early and lower your investment costs.

If you are unsure about total costs of investing, read the 2-part blog we wrote last year on total costs of investing - What is my total cost of investing? (Part 1) and What is my total cost of investing? (Part 2). Speak to your advisor or the person that sold you the funds, and ask how much you are paying on the mutual funds you hold and then assess the true value you derive. Here is another resource to check on the cost you may be incurring - Mutual Fund Fee Calculator.

Alternative solutions
Just to clarify, costs of investing is certainly not the be all and end all of investing. However it is an important element that you should pay attention to, especially in a modest-return environment that we are currently in, which is expected to continue over the next several years.

The good news is that there are ways to lower your costs of investing without compromising on the quality of the portfolio you hold.

Exchange Traded Funds (ETFs) are very effective investment products to own in your portfolio. They not only lower the investment costs, but also prove effective in achieving the level of diversification you need in your portfolio to align with your goals. Speak to your advisor on including ETFs in your portfolio.

Here is a table of a few ETFs under various categories as a comparison to the mutual fund tables shown above. Note the very low MERs and the MER-Performance Ratios of these ETFs vs. the mutual funds.

ETFs vs Mutual FundsSource: Morningstar. Numbers in the table are as at the end of January 2015. MER-Performance Ratio is calculated by Invisor.

Incorporating F-Class Mutual Funds into your portfolio is another way of potentially reducing your total cost, while continuing to seek better risk-adjusted returns through actively managed mutual funds. F-Class Mutual Funds are a different series of the same mutual fund family with a much lower MER typically offered to fee-based advisors only, as they do not pay out any sales commissions. As a result, commission-based advisors, online brokerages and branches of financial institutions do not offer this series of the mutual funds to its customers. If you are currently not paying your advisor an explicit fee for service, you would most likely be invested in an advisor series or another series of a mutual fund with much higher MERs.

See the table below, which shows the comparable F-Class version to some of the higher-cost mutual funds shown in the tables above. Note the significantly lower MER on these products resulting in a lower MER-Performance ratio. The lower MER on these products also enhances the returns as compared to their higher-cost, advisor-series versions.

F-Class Mutual FundSource: Morningstar. Numbers in the table are as at the end of January 2015. MER-Performance Ratio is calculated by Invisor.

However, you should note that the fee-based advisors do charge a fee over and above the MER of an ETF or an F-Class Mutual Fund. Therefore, you should take into account the total costs, including the management fee, before switching to a fee-based service provider.

Call to Action
If you need help with constructing goal-based portfolios at a fraction of the cost that prevails in the industry today, contact a fee-based advisor that can do so, who will truly work on your behalf (meaning, someone that doesn’t get paid by fund companies and will select the most appropriate, cost-effective investment products for you without any conflicts of interests).

You may well be able to reduce your total cost of investing (Fund MER, plus investment management fee, plus any trading fees) to about 1% per year, which means you could have a lot more of your savings working for you by not having to pay for unnecessary costs of intermediation. Fee-based investment management services, until now, were generally available to high net-worth investors and institutions only. Now it is available to all investors and in many cases, with no minimum investment amounts required.

There are alternatives for you if you are currently invested in high-cost mutual funds. All you need to do is ACT NOW so you stand to gain in the long-term!

Invisor offers Canadian investors personalized investment management solutions at a fraction of the cost of traditional advisor models, without requiring any minimum investment amounts. Get started now to tell us a little about yourself and your goals, and we’ll find an investment solution just right for you.

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