Investors need to pay attention to their investment fees

There’s been a lot of discussion about mutual fund fees lately and Jonathan Chevreau of the National Post has been arguing head to head against one of the biggest mutual fund companies in Canada with some of the highest fees in Canada.

Rob Carrick, another personal finance columnist at the Globe and Mail also weighs in on ways to reduce mutual fund fees

David Chilton, author of the Wealthy Barber and The Wealthy Barber returns also criticizes fees in Canada on the Lang and O’Leary Exchange

The best part of these pieces is that it brings more awareness to the importance of fees.  Here’s three reasons, investors need to pay more attention to the fees they are paying on their portfolios:

1.    Fees directly impact returns

Most investors and advisor talk in the world of net returns.  If you are doing some financial or retirement planning, you have to use some projected rate of return.  Do you use 3%, 5%, 7% or some other number.  Everyone has their own idea of what a realistic return should be but let’s consider the number is going to be between 3% and 12% (which is a big range).

If you are assuming a 5% return, you are probably assuming that number is a net return (in other words, that’s the return you get after fees and expenses).  To achieve a 5% return, you need to get a 7% return (if we assume a 2% per year fee).  This math is difficult to rationalize.  28.6% of your return goes away in fees and you, the investor gets to keep 71.4% of the gross return.

The lower the return, the more unfair the split gets.  Check out this chart based on a 2% annual MER (which by the way is lower than the average retail mutual fund)

MER

2.00%

Target Net return

Gross return needed

Percentage of the gross return that goes away in fees

Percentage of the gross return that goes to the investor

1.00%

3.00%

66.67%

33.33%

2.00%

4.00%

50.00%

50.00%

3.00%

5.00%

40.00%

60.00%

4.00%

6.00%

33.33%

66.67%

5.00%

7.00%

28.57%

71.43%

6.00%

8.00%

25.00%

75.00%

7.00%

9.00%

22.22%

77.78%

8.00%

10.00%

20.00%

80.00%

9.00%

11.00%

18.18%

81.82%

10.00%

12.00%

16.67%

83.33%

11.00%

13.00%

15.38%

84.62%

12.00%

14.00%

14.29%

85.71%

If we use a 2.4% annual MER (which is closer to the average), the numbers naturally get worse:

MER

2.40%

Target Net return

Gross return needed

Percentage of the gross return that goes away in fees

Percentage of the gross return that goes to the investor

1.00%

3.40%

70.59%

29.41%

2.00%

4.40%

54.55%

45.45%

3.00%

5.40%

44.44%

55.56%

4.00%

6.40%

37.50%

62.50%

5.00%

7.40%

32.43%

67.57%

6.00%

8.40%

28.57%

71.43%

7.00%

9.40%

25.53%

74.47%

8.00%

10.40%

23.08%

76.92%

9.00%

11.40%

21.05%

78.95%

10.00%

12.40%

19.35%

80.65%

11.00%

13.40%

17.91%

82.09%

12.00%

14.40%

16.67%

83.33%

At a 5% net return after fees, the fees accounted for almost a third of the total gross return and the investor only got two thirds of the total gross return.  What do you think of that split?

2.    Fees are imbedded.

Although fees are disclosed, they are not visible day by day.  When you pay a fee directly, you are more aware.  When it’s imbedded, you may not realize you are paying the fee.  On a $10,000 portfolio, you are paying $200 to $250 per year in fees.  If your portfolio grows which you hope it does, then your fee grows accordingly.  On $50,000 you could be paying $1000 to $1250 per year in fees.

I see people who go to great actions to avoid paying $1.50 interact fees when they take money out of the bank machines but yet they are oblivious to the fact they are paying hundreds or thousands of dollars in portfolio or mutual fund fees.  A 25% reduction in fees can mean hundreds and thousands of dollars back in your pocket instead of someone else’s.  Just because you can’t see the fee you are paying every year does not mean you should ignore this significant fee.  The irony is imbedded fee means investors have to pay more attention to fees and not be afraid to ask questions.

3.    Higher Fees for active management are tough to justify

Many investments with higher fees justify the fees on the basis of an active management strategy – someone buying and selling trying to beat the market benchmarks.  Fees drag performance down.  It’s kind of like running a race pulling a tire behind you.  The bigger the tire, the longer it takes to finish the race.

The problem is the probabilities work against you.  Most active managers don’t beat the indexes.  So you have the certainty of paying higher fees with a low probability of success.  That’s not putting the odds in your favour.

Lowering the fees is a certain way of increasing the probabilities of increased returns.  It does not guarantee higher returns but increases the probabilities dramatically.  If you want to check out some of my research on mutual fund fees, here’s a couple of links:

Mutual Fund Fees do matter
Mutual funds underperform the benchmark
The ongoing mutual fund fee debate

It’s tough to argue against lower fees.  Lower fees is better for investors.  It’s that simple and for that reason, investors need to pay more attention to fees.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

6 Responses to Investors need to pay attention to their investment fees

  1. It’s strange to think that people don’t always pay attention to what fees they are paying, but I do believe that this is true. I know I have found myself paying for things without realizing it in other areas. I can see how this could happen here. That chart on the split with the lower return is definitely interesting and something to keep in mind. Thanks for sharing!

  2. Jim – this is awesome stuff. I love how you put the costs out there in black and white.

    What would be awesome is if you had a developer put together a form where you enter a given MER and it spits back the splits of what you keep versus the fund company.

    That would be a very useful tool!

  3. Hi Jim

    I liked the article and yes, few people fully understand the effect of fees and the difference it can make to their investment.

    I recently ran a similar article here in Australia Financial Adviser Fees – The Cold Hard Facts. Despite a few calls from advisers directly to me (I have over 25 years in the industry) not one challenged the facts. Feel free to use the article if you wish. Cheers

  4. I have investments with Great West Life at the moment of just over $170,000. They say my former employer pays for some of the management fees. My cost is 1.533.
    My bank says they will manage my investments for an annual fee of $50.00.
    Which would it be wiser to go with?

  5. After 10 years with an “advisor” invested in mutual funds, the advisor made about the sme as me! Have happily moved this year to a robo advisor JustWealth, and could not be happier with my returns.

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