I came across an interesting video on CBC News featuring David Chilton, Amanda Lang and Kevin O’Leary. They were discussing the high costs of Canadian mutual funds, as well as some of the pitfalls to avoid when using ETFs. It’s just over a year old, but well worth a look.
Highest Mutual Fund Costs
It starts off saying that Canada has the highest mutual fund costs of the 22 countries studied in a recent Morningstar report, meaning we’re paying more to invest our money than anyone else. We pay a median price of 2.31% for equity mutual funds, compared to 0.94% in the U.S.
Related: Mutual Fund Fees – The High Cost Of Canadian Funds
Fees matter. Paying an extra one or two per cent per year in costs can take a huge bite out of your investment returns. Consider this example of a $10,000 investment:
- With a 0.5% fee on $10,000 invested over 45 years, your money manager will make nearly $18,000 while the investor makes $72,000.
- With a 2.5% fee on $10,000 invested over 45 years, your money manager will make over $60,000 while the investor makes less than $30,000.
Chilton says the problem is the fees are embedded inside the mutual fund and so we don’t even notice them. It doesn’t feel like a lot of money because it’s not like we’re writing a cheque to our advisor every year.
Related: Fee Only Financial Planner vs. Commission Based Advisor
He says the bottom line is Canadian investors were unaware of fees for some time and we’ve become tolerant of mutual fund costs that are too high.
When stocks markets were soaring in the 80’s and 90’s, this wasn’t a problem. But investors have started to wake up over the last decade as the markets have struggled and lower cost products like index funds and ETFs have emerged.
There’s pressure on the mutual fund industry to bring fees down. Investors Group, known for selling high MER products, reduced management fees on two-thirds of its mutual funds in 2012.
ETFs: The Good And Bad
The discussion turns to ETFs and Chilton describes how broad market index ETFs are good because their costs are just a fraction of most equity mutual funds. The problem, he says, is that over the last 5 years ETFs have gotten so niche-oriented and many of these products are not suited to the average investor.
Related: Why A Fiduciary Standard Is Needed In Canada
Kevin O’Leary brings up the point that many seniors are looking for income and most ETFs, particularly broad market ETFs, don’t offer much for yield. He says that since Income Trusts have been dissolved and corporate bonds are paying less than 4 per cent, the average Canadian senior can’t live off their investment income anymore.
Chilton argues that you can still look for ETFs that emphasize dividends, like CDZ which tracks the Canadian Dividend Aristocrats Index. This dividend ETF has a 0.67% MER and the yield is 3.62%. But hunting for higher yield north of 4% is going to come with additional risk.
Hidden Fees
A dividend mutual fund, on the other hand, can cost you as much in fees as you’re getting in yield. Indeed, TD’s Dividend Income Fund pays 2.02% yield and comes with a 2.02% MER.
Another problem in Canada is the management expense ratio (MER) doesn’t capture all the fees. There are deferred sales charges and front-end loads, not to mention tax inefficiencies when holding funds in a non-registered account.
Related: How Index Funds Compare To Equity Mutual Funds
Chilton goes off about some Canadian mutual funds charging up to 3%, which he calls outrageous and down right nutty. O’Leary, whose own branded mutual funds charge up to 1.9%, says 3% is an outlier and that Canada’s a free market and we’ve accepted higher costs.
Bottom Line
Hopefully Chilton is right and Canadian investors are waking up to the fact that we’re paying some of the highest mutual fund costs in the world. The more we can shift our investments towards lower cost index funds and ETFs, the more pressure the investment industry will be under to lower its costs.
When it comes to investing your money, high investment costs are your real enemy. The more you allow the financial industry to take, the less you’ll have in retirement.
Related: Avoid These 4 Investing Mistakes
These are really important lessons for investors. Here’s the full nine minute video – enjoy!
A Statistics Canada study indicates that more Canadians are cashing in their RRSP savings long before they reach retirement.
The money tucked away in your Retirement Savings Plan can be a tempting source of cash. But think twice before withdrawing money from your retirement nest egg. The amount you withdraw is considered income for that year and taxed accordingly.
Unless the withdrawal is made under the Home Buyers’ Plan or the Lifelong Learning Plan, you’ll immediately be hit with a hefty withholding tax, which may not cover all the tax payable. Over the long term the cost of dipping into your RRSP early is even higher.
Trying to save on interest costs
Early withdrawals from your RRSP have hidden costs that can do long term damage to your retirement plan. Consider this example:
Jason has diligently contributed to his RRSP every month and now has a sizable investment of $100,000. He wants to buy a new car and needs $25,000.
Related: Is An RRSP Loan Necessary?
He can take out a loan, but he doesn’t want to pay the loan interest. On the other hand he can use some of his retirement savings. After all, he thinks he still has lots of time to save before he’ll need the money for retirement. What’s the best option?
If Jason takes out a $25,000 loan at an annual rate of 7.5 % over 5 years, he’ll pay about $5,060 in interest costs.
If he taps into his RRSP to buy the car, he’ll actually have to withdraw $35,715 ($25,000 plus $10,715 to cover the mandatory 30% withholding tax). This leaves his RRSP with $64,285.
Assuming the remaining balance grows at an annual compound rate of 4% over the next five years, his RRSP will increase in value to $78,212.
If he had left his plan intact, he would have $121,665.
In other words, the loan would cost about $5,000 in interest over five years while the RRSP withdrawal would cost him more than $43,000.
Related: Is Your Investment Loan Tax Deductible?
This doesn’t take into account any additional income tax that may apply when filing his tax return and, unlike with a TFSA, there is no opportunity to replace the borrowed money, as the contribution room will be lost.
Over 20 years, the cost of the lost compounding rises to $95,208.
Using government programs
An RRSP withdrawal made through the government’s Home Buyers’ and Lifelong Learning programs is not subject to withholding or income tax. However, you have to repay the money in equal installments over the next 15 years.
If you miss a repayment, the amount will be added to that year’s income and taxed at your marginal tax rate.
Many will argue that higher education is an investment in greater future earnings and a house is an asset that will appreciate over time.
Also, borrowing from savings to purchase a house will allow you to make a more substantial down payment which enables you to avoid or reduce CMHC mortgage insurance fees and build the equity in your home faster.
Related: Why You Should Avoid Mortgage Life Insurance
However, the combination of a large withdrawal and a slow repayment schedule can have a significant impact on the growth of your retirement savings so think it through carefully.
While you don’t lose the contribution room, you will lose several years of tax-sheltered compound growth while you repay the loan. The faster you’re able to pay the money back, the less growth you will lose.
Conclusion
Dipping into your RRSP for quick cash may seem tempting, but is it a wise move financially?
Over the long run it will likely prove to be very costly and will damage your retirement plan. The withdrawal of even a small amount can have a substantial impact on the value of your savings and you will have to adjust your plan to ensure that you’ll still have sufficient funds to afford the lifestyle you want.
But what if you need funds? If a financial emergency arises and you need cash, look at other alternatives first before making an RRSP withdrawal.
Consider your non-registered assets or TFSA. A line of credit will offer a lower interest rate than a fixed term loan.
In most cases, though, it’s better to use the many different, more suitable, savings options available to you for both emergencies and future purchases.
Winter is now officially here and many Canadians are thinking about a trip to a sunny Caribbean destination to escape the ice, slush and snow. Destinations like Cuba, Mexico, Jamaica, the Dominican Republic and many more are eagerly awaiting their snowbird clientele.
Many of us will opt for an all inclusive resort where the food and drink flow non-stop. After all, we’ve worked hard and now it’s time to escape the cold weather, work and just relax!
Related: Snowbirds – What You Need To Know
My question to you though is: how many times have you been to a resort?
Planning a vacation to a resort is effortless. Everything is taken care of including flight, airport transfer, accommodation, food & drinks, activities, etc. Resorts make it easy for us to go back over and over again.
While we might get a good tan from sitting on a beach all day, we don’t actually get to see or experience the place we’re visiting. Many of us get so caught up in all the activities offered by the resort that we come back home feeling like we need a vacation from the vacation!
This year, consider a different approach to the Caribbean winter get away, travel for the experience!
Accommodation
Instead of booking a seven night all inclusive package, consider staying in a hotel, guesthouse or eco lodge. Vacation rentals by the owner offer a good mix of living like a local and enjoying a sun destination.
AirBnB has hundreds of options to choose from for all budgets. A search of properties in Jamaica to rent during the winter resulted in options from $13 per night for a dorm bed to $2,000 for a full luxury villa with all kinds of options in between.
Food & Drink
I know, I know, resorts offer up all kinds of food and limitless alcohol. At the beginning of a trip to an all inclusive you’ll think of all the food you will eat and the litres of exotic cocktails you’ll consume. At the end of the trip, you’ll look down at the scale and instantly regret your dietary priorities.
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The food gets tiring after about day 3. A la cart restaurants are often horrendously busy and even having all you can drink gets a little boring. How many rum punches, daiquiris and other umbrella drinks can you really guzzle down in a week?
By not staying at a resort, you give yourself the option to enjoy real local cuisine in an environment which hasn’t been carefully controlled for tourists. You’ll be able to experience the local food, not just consume it.
Activities
Open any package holiday guide and read up on the activities available at various resorts. They will include a variety of the following: pool, beach, nightly variety show, beach volleyball, dance classes, bingo by the pool, tennis, gym, spa, snorkeling, scuba diving, golf and more. With water sports as the exception, all of these can be done in your home country.
When you go to a resort you’re really going to do many of the same activities that you would at home but in a hot country with palm trees! Granted the setting is more pleasant but you aren’t really experiencing the country.
Related: 6 Free Mobile Apps That Make Travel Easier
If you want to experience a Caribbean country through activities, here are a few options.
Option 1) Go out and enjoy the natural surroundings on a tour or on your own
Option 2) Just hang out with friends and family and practice the art of not doing anything
Option 3) Play soccer with the locals
Option 4) Go to a local market and barter for fun
Caribbean sun destinations are not the most well off economically. Locals aren’t out hang gliding, golfing or going to a spa! There’s a reason why the pace of life in these countries is slow, most local people are spending their time doing activity option 2!
Vacations are an investment too
Traveling is an investment just like a bond, stock or GIC. The more money you invest, the more time you spend researching investments, the better off you will be.
Related: Best Credit Cards For Travel Rewards
As I mentioned earlier in the article, booking an all inclusive vacation takes very little time and effort. So if the comparison holds true, how rewarding would this type of vacation be when compared with the alternative?
Planning a trip yourself and really experiencing a country can pay off for years in the form of great memories and a better understanding of life elsewhere.
Andrew Martin is a personal finance and investing blogger from Toronto, Ontario with a background in technology and a passion for travel. His blog, She Thinks I’m Cheap aims to help Canadians make more money by sharing facts, stories and advice.