Let’s say you’re in your mid-30s with $50,000 in retirement savings already under your belt. And let’s also say you diligently squirrel away $500 every month to add to that money pile. How much will you have when you retire 30 years from now?
The answer could be over half a million dollars — or nearly $200,000 less than that. And which it will be might not have anything to do with your investment returns. The difference could simply be the fees you paid over the years.
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With high-fee investments, “Canadians are getting 100 per cent of the market risk and only 50 per cent of the returns,” said Larry Bates, a veteran of Bay Street turned investor advocate.
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That is, roughly, what happens in our example.
Assuming you’re a moderate-risk taker, you can reasonably expect your investments to grow by an average of five per cent per year (this irons out the ups and downs of the market, like boom years when your investments might grow 20 per cent and crashes when you might lose almost as much). If you were paying just 0.5 per cent a year in fees, your net investment gain over 30 years would be around $330,000, Global News estimated using the Ontario Securities Commission’s compound interest calculator.
But if your fees were 2.5 per cent per year, what you’d get to keep would be only around $140,000.
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Contrary to what many Canadians assume, those fees are a percentage of the total investment balance — not of annual investment gains. That makes a huge difference.
Let’s look at year one: If your initial $50,000 grows by five per cent, you make $2,500. If you were paying two per cent of just that $2,500, you’d be looking at just $50 in fees for the year. But you’re actually shelling out something closer to two per cent of $52,500, or around $1,000 for the year.
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Those fees add up fast and they lower your investment returns. A 2.5 per cent fee essentially means your investments are growing at just 2.5 per year rather than five per cent per year. With a 0.5 per cent fee, you’d be enjoying a net return of 4.5 per cent.
Flagging the true cost of high fees is the main mission of Bates’ recent book Beat the Bank: The Canadian Guide to Simply Successful Investing.
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Recent data suggests that more and more Canadians are heeding that message, which the financial press has been spreading for years. So-called exchange-traded funds (ETFs), which usually mirror the performance of a market index of a set of companies and come with low fees, are set to surpass sales of higher-cost mutual funds for the first time in a decade, according to recent reports.
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But Canadians continue to have $1.5 trillion of their wealth tied up in mutual funds, which usually charge fees of between one and three per cent, compared to just $156 billion in ETFs, the investment vehicle preferred by robo advisors, whose fees are in the neighbourhood of 0.5 per cent.
Part of the problem, Bates said, is that “people trust their advisors and their banks.”
Financial advisers often receive compensation — via something called trailing commissions — when they sell mutual funds. As small-investor advocates have long warned, this creates an obvious, potential incentive to steer clients to higher-cost investments.
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Another issue is that fees are difficult to detect and understand. Thanks to new rules that came into effect at the start of 2017, it’s now easier for Canadians to see what’s in their investments and what fees they’re being charged through a document called Fund Facts.
But investors still never see “a proper bill,” Bates said, “most have no idea of costs.”
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A third obstacle to moving away from pricey investments is a common perception that low-cost alternatives, like robo advisors, might also yield lower returns.
“People are used to thinking ‘you get what you pay for’,” Bates told Global News. “But it’s been said that with investing it’s the other way around: you get what you don’t pay for.”
In fact, Bates said, most mutual funds yield lower returns than ETFs that reflect market indices.
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Another, even lower-cost option is building your own portfolio through a discount broker.
“If you take a bit of time to learn investment basics you can easily take advantage of these lower-cost alternatives, which are often offered by the banks themselves,” Bates said.
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That doesn’t mean that fees should become Canadians’ only focus, said Jason Heath, a fee-for-service financial planner and managing director at Thornhill, Ont.-based Objective Financial Partners.
Heath emphasized that he sees a “definite benefit” to seeking low fees. But if this becomes a single-minded focus, it can backfire.
For example, “not everyone is cut out to be a do-it-yourself investor,” he said. “If you buy high and sell low, saving one per cent in fees was all for naught.”
Similarly, he said, some of his clients value the ability to speak face-to-face with a portfolio manager — an option that isn’t generally available with robo advisors.
The important thing, Heath said, is to be aware of how much you’re paying and for what.
“If your own advisor can’t give you a straight answer to that, it’s a sign you’re in the wrong place.”