There are big decisions involved when investing for your retirement. At least that’s what the mutual fund industry would like you to believe.
According to Wealthsimple, there are over 5000 mutual funds offered by Canadian investment firms. With that many options, it’s no wonder why people are overwhelmed and frozen to action.
Canadians pay some of the highest mutual fund fees in the world.
The companies that run these funds aren’t interested in making you money. They’re interested in making themselves money.
Investors take all the risk, put up all the money, and the mutual fund managers make money whether the fund goes up or down. All that matters to them is Assets Under Management (AUM).
If your financial advisor tells you that you don’t pay fees, RUN!
Some financial advisors or financial dealers will tell you that you don’t pay and direct fees. Which is technically true I guess. If mutual funds did charge direct fees nobody would invest in them because investors would know exactly how much they were paying for a fund. The fees for mutual funds are hidden.
Most financial advisors don’t have your financial best interest at heart. This is because their financial goals are in competition with yours. Financial advisors aren’t fiduciaries. They want to put you in funds that give them the highest commission. Of course they want the fund to rise in value and make you money too but often there first goal, is the get you into a fund that makes them money.
What is a mutual fund?
It’s a basket of stocks and/or bonds picked by an active fund manager. The key word here is active. The fund manager is consistently buying and selling stocks because they are ‘experts’. Unfortunately, they rarely beat passively managed funds.
95% of Mutual funds don’t surpass the index they are trying to beat.
As Canadians, we are comfortable with percentages like General Sales Tax (GST) (5%), PST (7%) or HST (15%).
So when we hear that a mutual fund only chargers 2.4%, we think oh my goodness, that’s low. So when you are starting out, a $1000 investment will cost you $24 in fees per year. That doesn’t seem so bad. You’re right, it doesn’t seem that bad. What is bad is that these fees will continue to increase and erode your portfolio.
If you are a high income earner and diligent saver, you many eventually accumulate $1 000 000 in your accounts. 2.4% on $1 000 000 is $24000.
Ask yourself, is my financial advisor giving me $24 000 of advice every year?
How do Mutual Funds make their money? Lots of FEES!
Mutual funds charge so many different fees it’s difficult to keep them all straight. What adds to the confusion is an ‘advisor’ sidestepping questions about fees and only telling you as little as possible.
Remember, a financial advisor’s goals are in direct conflict with your goals. Their goal is to sell you a fund that will make them the most money. It’s not in their interest to sell you a fund with low fees. Let’s go over the big fees you could be paying by investing in mutual funds.
Initial Sales Charge or Front-End-Load – This charge is often paid directly to the person who sold you the mutual fund. This fee can range from 0%-5% of the amount invested. You may be able to negotiate this fee with your financial advisor.
Example: If you buy $5000 of a mutual fund and the advisor has a 2% sales charge, then you’ll pay $100 to the advisor and $4900 will buy the mutual fund. The fees don’t stop there.
Back End Sales Charge or Deferred Sales Charge (DSCs) – It’s hard to avoid mutual funds fees but your advisor may give you the option between an initial sales charge or a back end sales charge. A back end sales charge can also be referred to as a deferred sales charge (DSC). DSCs work on a sliding scale. If you sell your fund in the first year, you will pay more than if you sold in the fifth year after the purchase. The DSC will eventually decline to 0%. This charge locks you in to the fund and discourages you from leaving. Ultimately, it helps the fund company keep their AUM as high as possible.
Thankfully, DSCs are now banned in Canada since June 1, 2022. This money went straight to the mutual fund company. But if you bought before then, the deferred sales charge can still apply to you. It just can’t be applied to any future purchases.
Management Expense Ratio (MER) – This is the biggest fee you will pay for a mutual fund. While the front-end and back-end charges are one time fees, the MER is paid continuously throughout the time you hold the fund.
Example 1 – if the fund increases in value by 8% and the MER is 2.5%, you will earn 5.5% on your investment.
Example 2 – if the fund stays even for the year (0% increase), you still pay the 2.5% so your investment in that particular fund will decrease by 2.5%. You will lose money if the market stays evens!
The investor takes all the risk! The mutual fund company and your advisor make money when the market is up or down.
Trailing Commission – is included in the MER. This portion of the MER gets paid directly to your advisor to compensate them for all the advice they give you (eye roll).
How much can you save by switching to a low-cost mutual fund or index fund?
Below is an example of the difference a 2% return can make over the course of 30 years.
The difference is shocking! That extra 2% fee over the course of your lifetime adds up to almost $400,000.
Conclusion and Recommendation
With so many investment options out there, it’s easy to get overwhelmed and settle for whichever fund is recommended to you. If you are currently invested in mutual funds, don’t panic and withdraw all your money. Try setting up a discount brokerage account and begin investing in low cost mutual or index funds through Vanguard or iShares. You’ll begin to see the difference over time as your investment egg grows.