Fees: your portfolio’s silent killer

Is your portfolio hemorrhaging money in the form of fees? Find out how to plug this profit leak!

If you’re like most investors, you’re probably concerned about the returns you get in your portfolio. If they’re reasonably high, it’s all good, right? Not exactly. In fact, while you’re counting your spoils, you may quietly be losing a large portion of those returns in the form of fees, which can drag down your portfolio returns by several percentage points in some cases. The truth is that the fees you pay are as important as the returns you receive because they all add up to how much money you get to keep. Find out what you can do to make sure you get the best overall returns by pulling the plug on high fees.

Types of fees and how to tackle them

There are a few key types of investment fees you’re likely to face, whether you have a basic retirement plan or a high-powered stock portfolio.

1. Management expense ratios

According to Morningstar Inc., an independent investment research company, Canada has the highest mutual fund costs compared to 22 other countries surveyed. These costs typically consist of management expense ratios (MERs) - the percentage fees embedded into mutual fund investments. The average mutual fund fee is 2.5 percent, but it depends on the type of fund you choose. Index funds – baskets of stocks designed to mimic an index – have lower fees, while traditional mutual funds have higher fees. F-class funds, which are designed to be held in a fee-based account, have low MERs because they strip out the portion of the MER normally paid to the investment advisor in the form of a trailer and allow the advisor to charge that fee directly, thereby making it tax deductible. If you own a traditional mutual fund, you are paying for this advisory fee, so make sure you’re actually getting the advice. Also consider that if you’re buying funds via your online brokerage based on your own research, you could be paying this fee for advice you may never receive.

To put the fee differential into perspective, let’s take a look at what higher fees mean for mutual fund investors. Suppose that you contribute $5,000 per year to a mutual fund account over a 25-year period. The account earns a modest 5 percent return. If the account’s MER is on the low end, at 0.5 percent, you will have more than $232,000 at the end of the 25-year period. If your account has a 2.5 percent MER, you will have just over $172,000. What does this mean? You’ve paid a full $60,000 to fees! Obviously, that kind of money can go a long way towards other means, so it pays to spend some time looking into how much you’re truly paying out in fees.

But what about the performance of the funds?

This may surprise you...most studies indicate that funds with higher fees rarely outperform index funds, which tend to have fees on the lower end of the scale. Part of the reason for this is that the large mutual funds found at many major financial institutions have so many participants that they can do little more than closely track major indexes such as the S&P 500 or the TSX. This happens when the fund becomes too large to invest in anything but the large cap stocks that dominate these indexes.

So, the logic goes, why not just save fees and invest in these indexes directly? Well, if you’re unconvinced about investing in passive investments such as index funds, consider finding lower-cost actively managed funds. After all, a penny saved is a penny earned!

2. Trading fees

If you have a stock portfolio, you will probably be subject to trading fees each time you buy or sell stocks. This fee ranges from $10 to $40 per transaction for a discount brokerage, depending on the institution and type of account, as well as the amount of money you’re holding in that account; more money tends to mean lower fees (no fair, right?). For a full service brokerage, fees can run into the hundreds of dollars per transaction.

While it’s a good idea to do some research into trading fees before you open a brokerage account, what impacts these types of fees the most is how often you trade. Most advisors recommend a buy-and-hold approach, in which stocks are chosen carefully for their potential growth and held over a long period of time. This type of trading helps reduce the amount lost to fees. The other option is active trading, which involves some seriously nimble manoeuvring in and out of stocks to capitalize on relatively small market moves. If you go this route, you will need to be working with relatively large sums – and know what you’re doing – to come out ahead.

3. Hidden fees and charges

No matter what type of investing you do, there will probably be a number of fees attached to that account. For example, many mutual funds have early redemption fees, which are charged if funds are removed within a certain time period after being deposited. Mutual funds may also be subject to load fees, which are paid when the investment is purchased, and transfer fees for moving from one fund to another. Similarly, brokerage accounts may charge quarterly or yearly fees and fees for inactivity.

Mutual fund fees must be disclosed, by law, in a mutual fund’s prospectus. For stocks and options traded through a brokerage, information about fees can be found in the commission schedule and statement of disclosure of fees and rates. These are generally thick volumes of paper written in fine print. It’s no beach read, but we’re talking about thousands of dollars of your money here, so it’s worth taking the time to sit down and give them a thorough once-over.

Don’t forget about the tax planning!

You’re probably too sophisticated and savvy to stuff money into your mattress, right? Of course. As such, financial fees - much like paying for parking or tipping your hair stylist – are expenses you just have to budget for. That said, a few fees can be deducted. These include fees, as discussed above, that are paid to investment advisors in fee-based accounts, which are declared on line 221 of your tax return. Check with your accountant about what types of financial advice qualify.

Another to-do: approach your advisor for clarification on the fees you are paying and work with her to create a low-fee portfolio, as well as ensure the advice portion of the fee is tax-deductible. Smart girl...this may just be your ticket to the highest returns and lowest fees possible.

The final word on fees

If you’re concerned about your investment returns, you should be equally interested in the fees that eat into those gains. In many cases, high-fee investments can suck tens of thousands of dollars right out of your account. The good news is that a little research goes a long way. Feeling empowered? Now go out and make sure you’re getting the most for your money!

 

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