Cheap but effective investment strategies
By Jim Middlemiss • Bankrate.com

Canadians love a bargain. Just look at Boxing Day blowout sales if you need proof. But when it comes to investing, our thrifty ways fly out the window. How else can you explain that some mutual fund companies charge management expense ratios, or MERs, exceeding 3 percent? Or that many Canadians use full-service brokers for trades they could execute at a fraction of the cost through a discount broker?

"Management fees have a huge impact (on investment returns)," says Eric Kirzner, the John H. Watson chair in value investing at the University of Toronto. "MERs have been too high in Canada for a very long time."

Every dollar you pay a money manager is one less dollar in your pocket, so it pays to find the best deal. Here are some shopping strategies to consider when it comes to your investments.

A typical Canadian equity fund charges about 2.5 percent, which means 2.5 cents of every dollar you invest goes toward expenses each year. So, a fund manager must earn at least a 2.5-percent return simply to break even.

If the S&P/TSX Composite Index rises six percent, then fund managers who use it as a benchmark must actually earn an 8.5-percent return -- a whopping 40 percent more -- to offset costs and keep pace with the index.

That's a tall order. According to Standard and Poors, only 35 percent of active fund managers beat the Canadian equity index, and only 26 percent of active managers could beat the U.S. equity index.

So how do you make a decent return? You can improve your odds by looking for funds with low MERs. For example, some of the big bank funds and no-load firms have Canadian equity funds that charge less than 2 percent. You might also consider iunits from Barclays Global Investors Canada Limited.

The i60, which tracks the main Canadian equity index and trades under the symbol XIU, for example, offers an MER of 0.17 percent, which is 90 percent lower than a typical fund MER of 2.5 percent -- a bargain by anyone's standard.

Barclays has a calculator that hammers home the impact high fees have on your investment's performance. For example, take two investments of $10,000 for 20 years: one in a Canadian equity fund with an MER of 2.54 percent and the other in the i60, at 0.17 percent. Assume each earns 10 percent annually.

The money in the Canadian equity fund would generate a gross return of $67,275. But once the MER worth $26,796 is factored in, you'd be left with a return of $40,479.

The money in the S&P i60 would also generate a gross return of $67,275 over 20 years. Once the MER of 0.17 percent, worth $2,459, is factored in, you'd have a net return of $64,816. That's 60 percent more return than in the equity fund. And that's why fees matter. You can check out the long-term impact of fees at the Investor Education Fund homepage.

Be wary of commissions
It's not just MERs you need to watch out for -- commissions can also be painful. When it comes to mutual funds, there are two types of commissions.

With a front-load commission, you pay a portion to the investment firm upfront, often 5 percent. So if you have $5,000, your actual investment into the fund is $4,750. The other $250 goes to the adviser.

With a back-load commission, also known as a deferred sales charge, you pay no money up front. But if you redeem the investment before the end of seven years, you pay a penalty charge, a sliding commission that decreases over time but can be as high as 6 percent.

There is no reason to pay any type of front-load commission for mutual funds. Most online brokerages let you buy them without a front-load or brokerage commission.

Warren Baldwin, a fee-only planner at T.E. Financial Consultants Ltd., in Toronto, says while advisers need to be remunerated for their work, if you spend 40 minutes with someone who takes a $500 commission, that works out to $750 per hour.

"Does that sound fair? Consumers need to understand what the sticker price of the unit is they are buying," he says.

The careful shopper can also find funds without back loads, which tend to be pricey. Of course, you can avoid the back-end charge all together by choosing an investment you feel good about sticking with for the long term.

Look for DRIPs
When it comes to individual stocks and bonds, commissions are all over the map. At a full-service brokerage firm, you could pay hundreds of dollars for a trade that costs $30 or less at a discount broker.

That's why you need to shop around. For example, if you only want to buy US securities, you can do so at Ameritrade.ca for US$10.99 a trade, which is half the price of most discount brokers. For more information, check out Bankrate.ca's story "Online brokers make investing easy".

Another way investors can cut commissions is by using dividend reinvestment plans, or DRIPs. Rather than have your dividends paid out in cash, some companies allow you to enroll in a program that automatically reinvests the dividends into new shares, often with little or no commission. You have to own at least one share to qualify and not all companies offer them nor do all brokerage firms provide access to them.

By reducing your fees, you'll have more money during retirement. The good news is fund companies seem to be listening to investor concerns about fees. Fidelity recently dropped the price of its MERs on some funds and Scotia Securities did the same. Other firms will likely follow suit, but it still pays to shop around.

Jim Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent contributor to National Post, Investment Executive and Wall Street & Technology.