Cheap but effective investment strategies
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
"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.
Look for low MERs
One of the most important things to look at is the MER, the fee a
fund firm charges to manage your money.
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.
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
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
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.