Doing the math on investment fees: the math isn’t pretty

A few weeks ago I invited readers to share their portfolio details with me so I could help ‘do the math’ on their investment fees. Many of you did, and the results weren’t pretty. From accounts loaded with deferred sales charges (DSCs), management expense ratios (MERs) in the high 2 per cent range, and funds overlapping the same sectors and regions, it was a predictable mess of over-priced products.

The worst of the bunch: the number of portfolios filled with segregated funds.

I’ve highlighted segregated funds as the biggest offender when it comes to fees for two reasons:

1.) The MER on segregated funds are higher than most mutual funds (which we know are already high enough). I looked at one portfolio that held a suite of segregated funds from Industrial Alliance called Ecoflex, with MERs of 2.99, 3.26, and 3.29 per cent;

2.) Segregated funds were exempt from CRM2 disclosure rules because they are considered insurance products. Investors receive the fund facts sheet, which still express fees in percentage terms rather than breaking them down and disclosing in dollar terms.

Doing the math on your investment fees


Keep in mind most readers were looking for me to do the math on their investment fees for portfolios valued at $250,000 or more. One reader, a soon-to-be retiree, had an average MER of 3.13 per cent for his $412,000 portfolio.

I told him he paid nearly $13,000 in investment fees last year and asked if he thought he was getting good value for his fees. He said he hadn’t met with his advisor in three years, despite repeated attempts to get together to discuss his retirement plan.

Another reader held $300,000 in high-fee mutual funds with Investors Group. She recognized the fees, but was on the fence about switching because she was in the middle of the deferred sales charge schedule:  a penalty that would cost her $10,000 if she sold the funds and transferred to a robo-advisor.

Not surprisingly, the big banks were also some of the biggest offenders for high-investment-fee portfolios. Despite offering a wide-range of in-house index mutual funds and ETFs, most bank advisors prefer to build portfolios with higher-fee equity mutual funds (and even some bond funds in the 2 per cent range for MER). That’s because those higher fee mutual funds are still considered to be ‘suitable’ for the investor while putting more money into the hands of the mutual fund manager and dealer.

The tyranny of fees


Why do I continue to harp on investment fees? The most obvious reason is that Canadians are simply over paying for their investments and not getting the value back from their advisors in other ways; such as financial planning, goal setting, estate planning, tax strategies, and retirement planning.

The other reason is what Vanguard founder Jack Bogle calls the tyranny of fees:

“What happens in the fund business is that the magic of compounding returns is overwhelmed by the tyranny of compounding costs. It’s a mathematical fact.”

In one example, Bogle explains that over a 50-year time horizon an investor paying 2 per cent in fees annually can lose 63 per cent of the potential returns in his or her portfolio.

Investors don’t notice because they don’t pay these expenses directly, but the fees will reduce the return on their investment. What starts out unassuming – 2 per cent on $25,000 is only $500 per year after all – becomes a compounding machine as your investment portfolio grows. A $250,000 portfolio at 2 per cent will reduce the investment return by $5,000. Annual returns on a $1M portfolio are reduced by $20,000.

What to look for in your investment statement

Investors should be receiving their annual investment statements at the end or middle of the calendar year, depending on the investment firm.

You should look for your personal rate of return, which measures not only how your funds performed but also how the timing and amount of your contributions and withdrawals affected your returns.

You’ll also want to know, in dollar terms, how much you paid directly to your financial firm for things like trading fees and account administration fees, plus how much you paid indirectly through trailing commissions.

For those invested in segregated funds and feeling left out, take heart. According to insurance regulators, by 2019 investors in segregated funds will have the entire amount revealed on their statement.

The Globe and Mail’s Clare O’Hara has a great explanation of what to look for in your annual statement, which you can read here.

Final thoughts

I was happy to do the math on your investment fees and shine a light on the ugly side of your portfolios. Most Canadians are overpaying for their investment products;  remember, more than $1.4 trillion is invested in mutual funds with the vast majority in commission-based mutual funds. Not only does investment performance suffer, many investors are not getting value for their money when it comes to advice on other financial matters.

Thankfully, there are enough choices out there for the average investor to save on investment fees. A do-it-yourself approach with low cost ETFs will cut fees to the bone, but might be too difficult to manage for some people. For those in-between, consider a robo-advisor to help manage your investments online.

In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on March 18th and is republished here with his permission.

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