In a recent Toronto Star column, I wrote that mutual fund fees in Canada are some of the highest in the world and because of these fees the vast majority of actively-managed funds lag behind the market. I said that switching to low-cost index mutual funds or ETFs will cut your investment fees to the bone while likely increasing your overall returns.
Joanne De Laurentiis, President of the Investment Funds Institute of Canada (IFIC), a mutual fund lobbyist group, apparently took issue with my column. She wrote in a letter to the editor that my advice to switch out of mutual funds was superficial and misguided.
Engen’s suggestion that Canadian mutual fund fees are among the highest in the world is simplistic at best. In the U.S., the majority of investors pay an additional fee over and above the U.S. version of the management expense ratio (MER) for their advisors’ services; whereas in Canada, all costs are included in the MER.
Canadian Mutual Funds: Highest fees in the world
I didn’t just pull that argument out of thin air. Back in 2011, Morningstar issued a report that compared total expenses of funds available to investors in 22 countries and found that Canadian fees were the highest for equity mutual funds and third highest for fixed-income funds and tied for highest for money-market funds.
The IFIC tried to pass off the Morningstar report as an “apples to oranges” comparison of fees around the world. De Laurentiis continued:
Recent research that took into account the different pricing models concluded that on a tax-adjusted basis (no HST in the U.S.), the asset-weighted cost (2.02 per cent) of owning mutual funds in Canada is virtually the same as the average cost (2 per cent) for a typical investor using an adviser in the U.S.
But things still hadn’t improved by the time Morningstar released its 2013 report. The report also offered a rebuttal to some of the earlier claims made by IFIC.
“Morningstar still doesn’t buy the “apples vs. oranges” excuse, finding that with “rare exceptions,” mutual funds in every country pay for distribution costs out of their funds’ expense ratios,” wrote Jonathan Chevreau in a Financial Post column.
According to the report, Canada does well across the board but is hampered by having the world’s highest total expense ratios. Morningstar found that Canadian fund investors pay up to 0.50% more in annual fund expenses per year than do investors in fund markets of a similar size elsewhere in the world.
Related: Chilton, Lang and O’Leary on Mutual Fund Costs
The value of advice
But De Laurentiis didn’t stop there. She claims that households who work with an advisor (assuming your mutual fund salesperson is also giving advice) end up richer than households who go it alone:
Reducing investment fees by buying products without the benefit of advice does not automatically translate into higher returns. All credible research shows that having an adviser creates a savings discipline and thereby produces superior financial results for the investor — more than 2.5 times more financial assets than households that do not receive advice. This is after all costs have been taken into account.
She’s referring to the CIRANO study, a research paper on the value of advice from a financial advisor. The study claimed that on average, participants retaining the service of a financial advisor for more than 15 years have about 173 per cent more financial assets than non-advised respondents.
Preet Banerjee examined the study in a Globe and Mail column and said it was a mistake for industry groups like IFIC to take the research as gospel.
“I spoke with Professor Claude Montmarquette, president and CEO of CIRANO and one of the authors of the study, and he indicated that the study is absolutely refutable given the limitations of the data,” wrote Banerjee.
Canadian Couch Potato blogger Dan Bortolotti said the IFIC and other industry spokespeople have been making the same claims forever.
“Even if you accept their “research” (which is inevitably commissioned by the industry), it doesn’t make a very compelling value proposition,” said Bortolotti in an email.
“They seem to have concluded that because wealthy people use advisors and poorer people do not, the advisors must be responsible for the difference in net worth. Talk about confusing correlation with causation. You may as well conclude that driving a Mercedes makes you rich.”
Final thoughts
It’s no surprise that the mutual fund industry and its lobby groups will fight tooth and nail to protect their nearly $1 trillion in managed assets (and associated fees).
It’s appropriate to end with this famous Upton Sinclair quote, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”
Imagine a world of total certainty – you know when you’ll die, how many times your car will crap out on you, what the markets will do, and if your third kid will need braces. In that world. figuring out exactly how much money you’ll need to save so that you can stop working entirely is just math, and the “it depends” part of the equation is limited to “it depends on how much you love/hate your job” or “it depends if you want to let your kids live with you until they’re 28” or even “it depends on whether you actually like lattes or not”.
Related: How do you choose your retirement date?
In the real world “it depends” is the equation. You have no idea what the markets will do for the 56 years before you maybe turn 95-if-you-live-that-long-but-what-if-you-live-longer (and neither does anybody else). You don’t know if your job (or your ability to work it) will be around in seven years. You’d like to retire at 60, but that’s a decade or two away and you don’t know if you can keep from murdering that guy who never refills the printer paper for that long.
Whether you’re one of those early retirement people, are planning on working until three o’clock on the afternoon of your 65th birthday, or someone who can’t even visualize what “retirement” really means (points at herself), retirement planning is the exercise you go through to figure out how much of your money you should realistically be setting aside for that inevitable day when you stop collecting a paycheque, or invoicing clients, or collecting ad revenue, whether that day comes at 37 or 67.
But why? The easy answer is “so I don’t run out of money when I’m too old/sick/hungover on the beach in Mexico to go out and earn some more”. An answer much closer to the truth is “so I know how much I should be saving so that doesn’t happen”, and one even closer to the truth – knocking on its door, in fact – is “so I can spend money now and when I’m not earning it anymore”.
The best retirement planning helps you spend more.
No, really.
It doesn’t always feel like it, and – no matter what anyone says – it’s an imprecise science at best, but planning for that inevitable day when you stop collecting a paycheque, or invoicing clients, or collecting ad revenue is an exercise that will let you spend more money than vaguely worrying about “saving enough” or “running out” will.
Related: Necessity Tetris – Retirement Income Edition
Now, don’t get me wrong. When I say “spend more money” I don’t mean “whatever you want, whenever you want”. I mean that if you put a realistic, measurable plan in place to fund your retirement – whatever yours happens to look like – with a reasonable margin of error that you review periodically, you will be able to spend more money than you would if you had plenty of worry but no plan.
We frown when we read the magazine articles about couples driving around Lexuses (Lexi?), facing a rapidly approaching retirement in which they’ll be lucky if they can afford a fifteen year old Dodge Caravan. Equally short-sighted, in my opinion, is living a Caravan life so you can drive the figurative Lexus at 67.
In theory, the metaphor-ridden path from Caravan to Lexus sounds great. It fits in with our collective bent towards modest living (in thought, anyway) and delayed gratification. In practice, there really is such a thing as saving too much.
Squinting myopically at the far-off future full of unicorns and rainbows and all the steak you can eat while smaller unicorns with one steak a week and rainbows every once in a while is right beside you is missing the point.
There is no universe in which I’ll become an extreme saver. I have lived the life of a budget so tight it leaves those elastic marks on my skin, and working out whether it costs more to blow my nose with a tissue from the box vs. two squares of toilet paper, or resenting the weather because having to run the dryer will cost me four cents is a chapter in my life I don’t care to re-read unless the payoff is really, really juicy.
Related: Why do we save?
“Making do” is all very well, but I don’t want to spend the next thirty years of my life “making do” so I can retire at 67 with a million dollars in the bank and with the “don’t spend” attitude etched so deeply into my psyche that I continue to count toilet paper squares.
Planning – whether you spend some time reading up and do it yourself, or you work with someone who’s actually interested in the exercise – moves you closer to balancing the equally important goals of Enough Now and Enough Later, and away from the the celebrated Hoping It Will All Work Out error and its less written about but more common cousin Vague, Guilty Worry.
Sandi Martin is an ex-banker who left the dark side to start Spring Personal Finance, a one woman fee only financial planning practice based in Gravenhurst, Ontario. She and her husband have three kids under five, none of whom are learning the words to “Fidelity Fiduciary Bank” quickly enough. She takes her clients seriously, but not much else.
Choosing the right investments for your goals is just the beginning. You need to monitor their performance to see how you are progressing towards those goals.
Many times investors look at their statements and check out the investment return. If the total has increased by say, 7 percent, from the last statement, they’re happy. On the other hand if their portfolio has lost 7 percent, they may be tempted to move on to something else.
Related: My 2013 Portfolio Rate Of Return
To assess how well your investments are actually doing, though, you need to evaluate performance against an appropriate benchmark.
What is a benchmark?
A benchmark is an objective standard against which the performance of an investment can be measured. Market indexes are the most widely accepted performance benchmarks and these are the most cited in the investment industry.
A benchmark index is comprised of the same or similar types of investments as are found in your portfolio.
How is your portfolio manager doing?
You may have noticed on your statement that your mutual fund performance is compared to a similar market index. Comparing returns to a benchmark is a way to measure the portfolio manager’s skill and to see if any value is being added relative to the fees being paid.
Related: Fund Facts About Mutual Funds
The difference in returns is called the tracking error. A low tracking error means the portfolio closely follows its benchmark. If it is high, it could suggest that additional risk is being taken to achieve certain returns.
You want to know if your fund manager is good, or is just investing in a hot market that makes him or her look good.
Compare apples to apples
How are your investments performing? To evaluate your portfolio’s performance you need to find the appropriate benchmark, or you’ll end up drawing the wrong conclusions. Look for the benchmark that tracks the investments that are the most like yours. With a diversified portfolio you may have to use more than one. Here are some examples:
- For bonds use DEX Universe Bond Index
- For broad based Canadian equities use S&P/TSX Composite or S&P/TSX Composite Total Returns Index (includes dividends)
- For Blue Chip stocks use S&P/TSX 60 Index
- For US Blue Chip equities use S&P 500 stock index
- For Global equities use Morgan Stanley World Index (MSCI)
- For International equities use MSCI Europe Australasia Far East Index (EAFE)
You can find a complete list of worldwide indexes here.
Related: When To Fire Your Investment Manager
Compare your returns over the long term, such as a period of 5 to 10 years.
If the market is strong but your portfolio value has remained flat, you may want to look more closely at your individual investments. Yet if your portfolio is slumping when markets are falling it may simply be reflecting market conditions.
How are your investments performing?
Let’s go back to our fictional investor above. He may not be as pleased to find his 7 percent return compares to a 12 percent market index return – it has underperformed. Likewise, he should be somewhat happier with his 7 percent loss when he learns that the market dropped 12 percent – it has actually outperformed the market.
Regularly measure and monitor not only your portfolio’s actual annual rate of return, also compare it to a specific benchmark.
Related: 5 Challenges DIY Investors Face
Without this step, how do you know if your investments are meeting your goals?