The great thing about managing other people’s money is that you can dip into it to pay yourself. This might sound unethical or illegal, but it’s perfectly legal if the owners of the money agree to it.
I use the word “agree” in a technical sense here; you really just have to get people to sign a document that points to other documents that bury the details of how you pay yourself from their investments. You might think that once people notice some of their money is missing, they would become wise to your scheme, but most people don’t notice. You might think that once such schemes are exposed in the media, people will see that they’ve been had, but most people who read essays like this one just don’t believe it applies to them. The sad truth is that millions of Canadians allow others to take their money this way.
How to consume 25 to 50% of your savings over a quarter century
Average Canadians invest much of their savings in mutual funds, segregated funds, and pooled funds offered by banks, insurance companies, and independent mutual fund companies. The bulk of these savings are invested in funds whose managers dip into the funds to pay themselves and their helpers at a rate that will consume between one-quarter and half of investors’ savings and investment returns over 25 years. This fact seems so incredible that most people will feel sure that it is wrong or at least that it doesn’t apply to them. But this draining of Canadians’ savings is real.
There are laws that require sellers of funds to disclose how much they take out of people’s savings each year. For example, when you first bought into a fund, you might remember receiving a large document called a prospectus that you found to be incomprehensible. Don’t feel bad; it’s designed to be incomprehensible because it contains news you wouldn’t like that might stop you from buying the fund. At least once a year your account statements have to include information about fees that get deducted from your savings, but these disclosures are often confusing, and they don’t have to include everything you pay.
You might wonder how it’s possible that so much of your money disappears without you noticing. The key is that it slips away a tiny bit at a time. If out of every thousand dollars you have saved, just one dollar disappears each month, over one-quarter of your money will be gone after 25 years. Make it two dollars per thousand that disappears each month and almost half your money will be gone in 25 years. You may have heard that the fees taken out of your savings are some small-sounding percentage like two per cent. This isn’t two per cent of your investment returns; it’s two percent of all your savings that disappears every year. Over 25 years, this builds up to almost forty percent of your savings and returns gone.
Can’t mutual funds make up for their fees with great returns? In general, no. It’s nearly impossible to make up for draining away one quarter to half of your savings over 25 years. Every year there will be funds that do well. But the next year different funds will do well. Over 25 years, most funds are just average, and investors who jump from fund to fund rarely improve the situation. The typical investor will end up with about average returns over 25 years before we account for the quarter to half the money carved away by fund managers and their helpers in fees.
Why don’t we hear more about this?
Why don’t we hear more about this issue? Much of the media, including bloggers and other financial commentators, depend on revenue from banks, insurance companies, and other businesses that make large profits from the status quo. This isn’t a conspiracy; it’s just a normal tendency to avoid biting the hand that feeds them. There are strong voices getting the message out about the damaging effects of high fees, but they tend to get swamped by advertising messages.
Is there anything Canadians can do about this drain on their savings without having to learn the intricacies of the stock market? The answer is yes. One very easy approach is to use a robo-advisor. Another is to find one of the few mutual funds in Canada that charge much lower fees. This requires some research into robo-advisors or lesser-known mutual funds, but it reduces the drain on your savings and returns to ten to twenty per cent over 25 years.
There are even cheaper ways to invest your savings without having to learn how to pick stocks, but they aren’t widely advertised. There are a few funds called all-in-one Exchange-Traded Funds [ETFs] that are inexpensive and widely diversified in global stocks and bonds. Such funds will consume only about six percent of your savings and returns over 25 years, but nobody is breaking down your door to sell them to you.
To invest in these all-in-one funds, you first have to learn enough about them to be confident in holding them for the long term through thick and thin. Then you need to open a brokerage account and learn to buy them. The process isn’t complex, but it takes some nerve at first to click the button to put thousands of dollars into a fund.
The easier path is to shake the hand of a smiling mutual fund salesperson if it weren’t for the pesky problem of giving up one-quarter to half of your savings and returns over 25 years. One of the most challenging parts of lower-cost investing is avoiding acting out of fear or greed as the stock market gyrates, something that an expensive financial advisor may or may not help you with.
Managing other people’s money is great for the managers, but not so great for investors if fees are high. The status quo is unlikely to change much until more investors learn about the fees they are paying. Some Canadians are waking up to better ways to invest, but the old high-cost mutual fund model is still going strong in Canada.
Michael J. Wiener runs the web site Michael James on Money, where he looks for the right answers to personal finance and investing questions. He’s retired from work as a “math guy in high tech” and has been running his website since 2007. He’s a former mutual fund investor, former stock picker, now index investor. This blog originally appeared on his site on Feb. 23, 2021 and is republished on the Hub with his permission.