Why You Should Pay Attention to Costs when Investing
I know reading about investment costs isn’t necessarily exciting, but bear with me; I promise there are some points in here that will make a significant difference to your nest egg.
If you want to invest, you’re going to incur some costs. In Canada, where Invisor is located, mutual fund fees are the highest in the developed world, nearly 3 times what they are in the U.S. This means it’s particularly hard for investments to grow (even more so recently in this lower growth environment) because there’s always the significant drag of the fee, cutting performance by a constant 2 to 3% every year. It’s reasonable to pay fees to have your money managed, but there are a lot of unreasonable costs that have somehow made a home in the financial world and really only benefit a small group of middlemen who distribute investment products to advisors (and maybe the golf courses they belong to).
Before identifying some key costs, let’s look at what 1% savings can do on a portfolio. These are two identical portfolios invested for 30 years and growing at 6%. One has a 1% additional fee paid each year.
The real impact to your portfolio
That 1% fee means your portfolio is worth $142,000 less. That’s 33% of its value. Fees themselves make up 15% of the 33%, but what’s also very interesting is the remaining 18%. Inefficiencies in the investment world (i.e. the high fees) essentially remove capital from the economy. In our example, that’s 18% of your wealth. That money didn’t stay in the market to help fund new investments, it doesn’t get spent on goods or services, it’s gone. Inefficiencies in our fee structure have reduced our economic growth potential.
What costs can you avoid?
Sales commission and trailers: i.e. the compensation an investment representative gets for selling certain funds to you. These fees can incentivize sellers to recommend funds that pay them more; they’ve already been banned in Australia and the U.K..
Some argue that without proper commissions, clients won’t receive proper advice and their investments will suffer. Like with anything, advice is great when you’re unsure. Good advice can go a long way in pointing you in the right direction and helping you stay on track during volatile times. But the cost for advice should be reasonable and transparent, and not create a conflict of interest (full disclosure, Invisor is a fee based advisory firm).
Fund management fees (MERs): higher cost doesn’t necessarily mean higher quality. In fact, it means more ground to recapture before outperforming. Cost is directly correlated with poor performance. In years, like this past one, where returns are particularly hard to come by, over 90% of US equity funds seeking to outperform the index failed to do so.
These days, it’s easy to build a well-diversified portfolio with low-cost ETFs which typically seek to match broader market returns, and they do a pretty good job of it.
Trading costs: each time you buy and sell securities there’s a cost. Whether it’s trading commission, currency exchange charges or the bid/ask spread. With the standard industry fees, the cost to buy then sell a security could easily be 1%. See the table above for the impact of 1% over time.
The message here is simple, trading is a part of investing. Just don’t over trade; spinning the tires only creates a deeper hole you have to get out of.
A wise man once said “compound interest is the 8th wonder of the world”. Although costs may seem small and incremental, they’ll play a significant part in your well-being down the road.
As we work towards minimizing this inefficiency in investing, not only will people live wealthier, but our economies will be wealthier too.