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Fees Suck. Amirite?
I know, such a bold statement to make. Fees are bad. From parking tickets to gym memberships to whatever the Bloody Hell Ticketmaster’s “convenience fee” is for, whenever I see the word “fee” written on something, a tiny piece of my soul (and wallet) dies a little.
But out of all the fees we have to put up with, one stands out as simultaneously the most damaging and the most misunderstood: Investment fees.
Quick, how much are you paying to invest? If you have no idea, you’re not alone. Investment fees usually don’t appear in your statement, and are instead embedded inside your mutual fund and taken silently out of the fund’s performance. Why would they do this? Simple! If you saw a line item that said $-500 fee, you’d call someone up and scream at them. But if your mutual fund just goes up slower than it should, you don’t notice. It’s brilliant!
And lucky you, we here in Canada have among the highest Investment Fees in the world!
Finding a fund’s MER may be as straightforward as just looking at the fund’s webpage, but if it’s not there it’s required to be shown in the fund’s prospectus. As an example, I went to a certain bank’s site and picked its “Canadian Equity Fund.” At the bottom there was a (tiny!) link named “Fund Financial Reports and Prospectuses” and that led me to the fund’s prospectus. When I clicked on that link, I saw a description of what the fund invests in, their top 10 holdings, and the MER. Which is a whopping 2.39%.
And don’t think I’m picking on that particular bank for sucking here. All the banks do this. In fact, the average MER of equity funds in Canada is 2.42%, so technically this fund is slightly…better, I guess?
Sorry, it’s just so hard to contain my excitement.
Meanwhile, an ETF tracking the TSX, which by the way, holds many of the same companies that Canadian Equity Fund up there is holding, has an MER of…0.06%.
That’s right. 0.06%. Almost 40x lower than a bank-run mutual fund.
Why is this important? Because any ongoing percentage fee eats into your fund’s performance, and just like gains can compound over time, fees compound also. Over sufficiently large periods of time, a couple percentage points paid to your fund can results in massive differences. Lets pretend, for example’s sake, that we went back 25 years and wanted to invest $100,000 in the TSX. So January 1, 1990, we buy $100,000 worth of either that mutual fund with a 2.42% MER, or the ETF with a 0.06% MER. On January 1, 2016, what does our investment look like?
The red line is the low-cost ETF and the blue line is the higher-cost mutual fund. Both are generally investing in the same stocks, but you will notice that while the lines start off at the same point, the difference between them grows and grows as the fees eat into our fund’s compounded growth, and at the end we are left with a huge gaping chasm. That gap is worth $100,000, JUST in fees!
And here’s the wild part. For most things, paying more money equals better quality, right? An expensive car is better than a cheap car, an expensive laptop is better than a cheap laptop, etc. This is NOT one of those times. Paying more does NOT mean a better product.
In fact, when it comes to Investing, the opposite is true. The more you pay, the worse the performance, because that fee just eats into your returns.
So what should you do?
First of all, if you’re looking at a fund and you can’t figure out it’s MER, DO NOT BUY IT.
Secondly, if a fund discloses its MER and it’s above 1%, DO NOT BUY IT. No mutual fund (or ETF) has a chance of giving you the performance you need with a handicap that big.
Mutual Funds vs ETFs
Generally, ETFs have a much lower fee than mutual funds, so a good rule of thumb is to always use ETFs over mutual funds. There is one caveat, though, and it’s to do with trading commissions.
Mutual funds generally cost nothing to buy/sell. This is because the cost of trading is built into the (higher) MER. ETF’s, however, are trade on the stock exchange, so there’s generally a per-transaction cost to buy/sell.
For TD Waterhouse, the cost to trade is $9.99 per transaction. They also offer low-cost mutual funds called “E-Series” funds, designed for Index Investing and with considerably lower fees than other bank-run funds. The Canadian Index e-Series fund, for example, has an MER of only 0.33%. While we were working and self-directing our investments, we would dump money into our investment accounts with each paycheck and buy more units of each mutual fund in our portfolio. We were using 4 funds at the time (Bonds, TSX, S&P500, International) Had we done this using ETFs, we would have racked up $10 x 4 trades per paycheque x 2 paycheques a month x 12 months = $960 a year in transaction costs alone.
In that scenario, it made more sense to use the e-Series mutual funds to dump our paycheques into it, and then when that total balance got big enough that the higher MER started to become expensive (we used $100,000 as our cut-off point), we sold the mutual funds and rolled it into ETFs that track the same indexes to take advantage of the lower MER.
But that was then. There are many more options for low cost brokerages now. Recently, our readers have alerted us to a whole slew of them…like Questrade and Qtrade. And for Questrade, you don’t even need to pay to buy ETFs, only to sell. And since it’s gotten so many good reviews, we’re going to try it ourselves and report back the results.
So there you have it. Fees suck, avoid at all costs by using ETFs. The only time you should ever use mutual funds is if the transaction costs are greater than the difference in the MER.
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It’s amazing the effects of such a small percentage difference in fees. I’ve run a whack of scenarios and if I outperform my target rate of return by 1% (less than the diff between a bank mutual fund and an ETF) then in a decade or so our portfolio will be growing faster than I can dream up ways to spend it – So Yes, fees matter a lot.
Another point to make is that many (not all) mutual funds are really just closet index funds, so they very closely mirror the holdings of the index, providing no value for their much bigger fees.
The TSX index is not balanced across sectors but rather heavy weight in energy, materials and financials, the former two which tend to run to the sky or crash and burn depending on the market cycle. So, depending on how a portfolio is constructed a reasonable fee fund that provides a more balanced-sector approach can make sense – but for those with solid US or Europe exposure it becomes less of an issue as the consumer and industrials exposure there offsets the tilt seen on the TSX.
Yeah, no kidding. Even I was surprised when I ran the numbers. I knew the results would look bad, but not THAT bad. And that fund I picked was basically a closet indexer. The damned prospectus said “This fund aims to replicate the TSX.” So I’m like, “then why don’t I just buy the TSX? What the Hell am I paying you for?”
From Rob Carrick’s twitter: https://twitter.com/rcarrick
http://www.fpsc.ca/docs/default-source/FPSC/projection-assumption-guidelines-2016.pdf
Dear GOD that paper was boring.
One interesting part however was the inclusion of the actuarial tables showing life expectancy. Apparently, “people who do not use tobacco, people from younger generations and people who are more financially comfortable” tend to live longer.
Just another reason to come with us! Become Financially Independent: You’ll Live Longer 🙂
Is it bad that I thought it was interesting, particularly the parts where it said most questionnaires to determine risk tolerance were completely mucked up?
The gent I replaced at work said he retired at 55 because if you work beyond 55, he had newspaper articles to prove your lifespan would be shortened.
Quick question, I hold 50% of my portfolio in VXC (https://www.vanguardcanada.ca/advisors/mvc/detail/etf/overview?portId=9548&assetCode=EQUITY##overview) which states a management fee of 0.25% and an MER of 0.23%.
What is the difference between these two? Are they two separate fees or one fee split into two? I’m trying to hold low cost ETF’s but that’s teetering on expensive for an ETF if they’re added together. Perhaps international ETF’s are more expensive than domestic as VCN (25% of my portfolio) is much smaller at 0.05% and 0.06% respectively.
The MER usually includes the Management Fee (http://www.investopedia.com/articles/investing/062113/mutual-funds-management-fees-vs-mer.asp), so generally it’s the MER you should care about. Though in this case it’s extra confusing since the MER is LOWER than the Management Fee. However in the fine print at the bottom, I noticed this:
The MER would have been 0.27% without any absorptions or waivers. Vanguard Investments Canada Inc. expects to continue absorbing or waiving certain fees indefinitely but may, in its discretion, discontinue this practice at any time.
So it looks like the “real” MER should have been 0.25% Management Fee + 0.02% trading costs (or whatever), but Vanguard decided to waive or rebate part of the fee resulting in the lower 0.23%, so the real MER is 0.23% as reported. This is my interpretation though, so you might want to shoot Vanguard an email to be extra sure.
Something interesting is happening right now in fee-land: new rules are supposed to force brokerages to clarify how much is paid.
http://business.financialpost.com/personal-finance/will-new-disclosure-rules-on-advisor-fees-affect-our-love-affair-with-mutual-funds
If the new rules are well written, this may chamge a lot of things for the better.
This entire debate is about forcing the finance industry to disclose what they’re actually doing. The fact they’re fighting this so hard is NOT a good sign. What the Hell piece of crap are you actually selling?
From our experience, the brokerage firm your account is moving to always offers to reimburse your transfer fees. After all, why wouldn’t they?
Hey guys,
We decided to go with Questrade. A few questions:
– what happens if an firm that created an ETF goes down (lets say Vanguard closes shop)? Lets say you own $100 in an a Vanguard VSP. That means that you own $2 of Google, $2 of Apple, $1 of Microsoft, etc. Can a failure of the company that started the fund cause an investor to lose ownership of the stocks that the ETF consists of?
– what happens if a trading platform (brokerage) company goes under (lets say Questrade goes bankrupt)? It seems that this would not affect an investor at all. Is that true?
– What are your favorite indexes? What’s your fav ETF for tracking each of those indexes? How about bond indexes? And REITs or preferreds? 🙂
What I don’t get is why there are so many ETFs tracking the exact same index? Does that not come down to very basic computer program that goes and looks up data on the net and then syncs that data with a local copy of it, slaps a MER on top and then sells it in a form of an ETF to us? Is there a way to buy the actual index directly from a certain stock exchange (such as Nasdaq) in a form of their own ETF?
Thanks for your work guys!
Great questions.
If an ETF goes down, your money is protected because ETFs are structured so that the fund company is responsible for day-to-day buy/sell decisions, but your money itself is held by a third-party custodian. If Vanguard goes belly up, your money is not claimable by creditors. More Info here.
As for your brokerage, we here in Canuckistan have something called the CIPF, or Canadian Investor Protection Fund. Member companies contribute into a common fund so that if one member goes bankrupt, the fund covers the losses sustained by the investors. If your brokerage is a CIPF member, your accounts are protected up to $1M. And before you ask, Questrade is a CIPF member.
My favourite indexes? The TSX, the S&P500, and the MSCI EAFE Index. For preferreds and REITs, I use the S%P/TSX Preferred Index and the S%P/TSX REIT Index. For bonds, the FTSE TMX Canada All Government Bond Index is the main one, but there are equivalents for corporate bonds, real-return bonds, etc. I’m not allowed to recommend individual ETFs though, as I’m not a licensed financial advisor.
And as for why S&P doesn’t make an ETF, can you imagine the outcry that would happen if a stock exchange listed its own ETF in the stock exchange? That’s the textbook definition of conflict of interest!
You convinced me, and I would like to try this but how would I find anyone willing to work with me? I have checked with my current financial advisor, and they don’t do it.. I am too afraid to do it on my own…Any advice? Should I just go on Facebook and ask who does it?