Let me start by sharing with you an email I got from Ellen who is one of my readers who posed an interesting scenario:
“My current portfolio is worth $177,797.71. I am concerned about the MERs (2.26%) I am paying and I am thinking of switching to the TD e-series funds (MER- 0.5%). The remaining Deferred Sales Charge (DSC) fees are $3160. Should I pay the one time DSC charge to save money every year?”
What is the DSC?
A deferred sales charge is sometimes called a back end load. Basically it's the fee or penalty for selling an investment before a specific period of time usually somewhere between 5 to 8 years. Often mutual fund companies will allow switches within a fund family but the DSC is charged if money is pulled out of the company. It's a way of locking the client into the fund because the mutual fund company had to pay the advisor an up front commission at the time of purchase and needs to recoup this cost over time.
Let’s look at the math
On a $177,797.71 portfolio with an MER of 2.26%, the annual cost of investment is $4018.23 assuming 0% growth.
If we compare that to the TD e-series with an MER of only 0.5%, the annual cost is 82% lower at $711.19. That’s a savings of $3307.04 per year every year. That’s pretty significant.
Should Ellen pay the DSC to get out?
In Ellen’s case, I think this is a no brainer from a mathematical perspective. It will cost her $3160 to get out but from that point forward she will save herself $3307 per year. She wins before the first year is over.
It’s not all about the math
I’ve said many times that we live in a world where everyone can manage their own investments. However, very few people are wired to do this properly. I meet thousands of people every year that so not have the knowledge, confidence, desire, time and/or passion to invest money themselves.
Anyone can save money in fees if they are willing to do it themselves. In Ellen’s case, she has to be confident that she has these qualities listed above.
Is her advisor adding value?
I’ve also said many times that Advisor must justify their existence and their compensation with some level of value. I don’t believe advisors can add value when it comes to providing higher returns on a consistent basis. The truth is they do not have the foresight or ability to control or predict the future.
Instead Financial Advisors must find other ways to add value beyond just focusing on the investments. This is where financial planning, retirement planning and estate planning can be a big differentiator.
Analyzing the investments
One of the other considerations that we cannot cover here is the comparison between the investments that she currently owns with the lower cost TD e-series funds.
Some advisors will argue that you might pay higher fees but the returns could be higher. Advocates of low cost investing would argue that over time, lower fees will win over higher fees. Who’s right?
I think you have to be careful when comparing past performance because it’s not a great indication of future performance. You can get different results when you look at different time periods and just because one investment outfperformed over the past 10 year period does not necessarily mean it will out perform over the next 10 year period.
I do believe lower fees matter over time. It’s like running a race with a 5 pound weight vs a 30 pound weight. The runner with a 30 pound weight is definitely at a disadvantage, especially over the long term.
What would you do if you were Ellen?