Banks Fleecing Canadian Investors With MER’s
I normally keep this blog on the topic of poker, but some recent discussions with family and friends have made me want to write about how high MER’s (Management Expense Ratios) are killing retail investors. So here it is…..
The Problem
Canadian customers pay far too much for horrendous service when it comes to investing in mutual funds. According to CBC article here the average Canadian MER is 2.5%. That means you are paying 2.5% of the total amount that you invest with them in fees every year.
Warren Buffet said that in the long run you can expect about a 7% return on the stock market based on very simple math (3% GDP growth+2% Inflation+2% Dividend Yield). Unfortunately, if you are paying an MER of 2.5% that is taking (2.5/7)*100%=35.7% of your total expected return!
Sadly, these MER’s are so high based largely on excessive spending and a need to drive profits higher, rather than the real cost of providing investment services. Worse still, the vast majority of actively managed funds underperform the indices. Think of it like this. You are essentially paying 35.7% of your total investment return as a fee for a horrendous product that doesn’t even match its benchmark. A recent study by SPIVA Canada revealed that 89.7% of Canadian Equity mutual funds failed to beat the benchmark (see article here). Even more US and International funds underperform their index. Fixed Income mutual funds also underperform massively.
Why Do Investors Buy These Products?
Retail investors continuing to invest in these terrible products with insanely high MER’s for a couple of reasons.
1) Because they don’t know any better
2) The system is set up to be confusing and draw them into a web of high MER’s and terrible investment products. This is because there is a financial incentive for the banks and their employees to keep you in the dark and charge you 10 or in some cases even 20-30 times what other comparable products are available for.
If you have a decent sum of money in your retail bank they will reach out to you and offer to have you consult for free with an Investment Advisor or Certified Financial Planner. Unfortunately, these people are part of the system that is fleecing you! I am not saying they are maliciously doing so, but slowly and surely they are picking the pockets of millions of investors at a rate of 2.5% per year.
A quick glance at some major bank MER’s reveals some terrible products. The RBC Canadian Dividend Fund charges 1.79% annually. Another randomly selected fund I pulled up The Scotia Canadian Dividend Fund has an MER of 1.7% as well.
Sadly, these are far from the worst products on the market, but they are still terrible for investors. MER’s that come close to 2% are still eating away at a huge percentage of your long run expected return.
The Solution
The solution for the average retail investor is indexing. Indexing allows you to obtain the overall return of the stock market so that you don’t end up underperforming like 90% of actively managed funds to, and it shouldn’t/doesn’t come with an MER of 2.5%. However, a word of caution about indexing…… Not all index funds are created equal, and you should be avoiding higher fee index funds. Even the TD bank index fund here with a 0.89% MER (half of the Scotia and RBC funds we just looked at) is still not a great product.
Indexing is not terribly difficult and requires very little effort on the part of the Mutual Fund Provider. They just need to keep an appropriate mix of securities so they match the return of the benchmark. Unfortunately, there are a lot of regulations which are meant to protect the consumer but actually push up fees instead.
ETF’s
In order to avoid paying high index MER’s of 0.89% you should probably avoid mutual funds altogether and buy ETF’s. They are essentially the same thing as a mutual fund, but they are traded on the stock exchange. You can see details about them here.
If you are looking for a low cost ETF provider Vanguard is the world leader. They offer incredible products at reasonable prices that will allow you to secure your investment future without giving away so much of your money to advisors and salesmen. Vanguard has over 2.5 trillion dollars in assets under management and is one of the largest asset managers in the world see here.
The Vanguard Canadian Index ETF’s have management fees of between 0.09% and 0.12%. That is about 1/25th of your median mutual fund MER in Canada, and about 1/8th of the fee that TD charges for their Canadian Index Fund.
The one downside of ETF’s is that you may need a brokerage account to buy an ETF since they are traded on the stock exchange. If you open an account with a discount brokerage like Questtrade they offer ETF trades for free!Even if you are not able to trade them for free it should cost you no more than $5 to make a trade. This means that you can buy in to a Vanguard Canadian ETF for $5 or less and then only pay 0.09%-0.12% to index the Canadian Equity Market. This is absolutely fantastic and about 25 times better than the median product you will find at a Canadian bank.
Asset Allocation
I wanted to add a quick word on asset allocation. You might say that it is difficult to know what to invest in or how much. When it comes to investing, a little bit of knowledge and a lot of patience goes a long way. Indexing the entire Canadian stock market is good diversification and a great first step toward building a good portfolio. The real question is how much of your portfolio should be allocated toward Canadian Equities, US Equities, International Equities, Precious Metals, and Fixed Income. That will vary depending on your risk tolerance. I love the FTSE Canada Index ETF that Vanguard offers at 0.09% MER. For US equities I like the S&P 500 Index ETF with an MER of 0.15%.
Personally, since I am only 28 years old, I like to have an aggressive allocation. When I invest in the stock market I like to put 40% in Canadian Equities, 40% in US Equities, 15% in International Equities, and 5% in Precious Metals. However, I have no need for immediate income and based on long-term historical equity market returns, I have a high degree of confidence these investments will do well.
There is an old rule of thumb that you should put 100% minus your age into the equity markets, and the rest into fixed income. This is a pretty good technique for most people, but I think with people living longer than expected it may be more appropriate to invest 110 minus your age into the stock market because you may need the extra growth the equity market brings if you live to be very very old.
If you were 50 a sample portfolio might include 110-50=60% invested in equities, and the remainder in fixed income. You could break up the 60% you are investing in equities along the following lines: 30% CDN Equity (FTSE Canada Index ETF), 25% US Equity (S&P 500 Index ETF), and 5% International Equity(FTSE Emerging Markets Index ETF).
As for the 40% you are putting into the fixed income market, I would put something like 30% into a product like the Vanguard Aggregate Bond Index ETF which lists its top 10 holdings as all being Govt. of Canada bonds. The remainder could go into a corporate bond fund such as the Vanguard Canadian Short Term Corporate Bond Index ETF which has an MER of 0.15%.
6) Finally, I want to sound a word of caution about stock picking. If you are tempted to stock pick, don’t! It can be very tempting to listen to those around you for stock picks, but in the long run this is actually a very bad idea. Remember that so called “investment professionals” who are running actively managed funds have a 90% failure rate at outperforming the indices. What makes you think that you can do better than them? The vast majority of you are much better off just indexing.
Having said all of this, I actually do personally stock pick with a very small amount of money. However, all of my serious investment money goes into real estate or Vanguard. My stock picking is solely for entertainment purposes. As silly as it may sound, I get a kick out of keeping track of a couple of stocks and trying to beat the system. However, I know the reality is that I, like 90% of professional mutual fund managers, will probably underperform the indices. But for such a small percentage of my investment money, I really don’t care too much and I’ll have fun in the process.
The Bottom Line
With just a few minutes of work and the help of Vanguard you can put together a portfolio that mirrors what you would get at a bank for 1/20th of the cost. The major Canadian banks have taken advantage of their retail bank presence and the general lack of investment knowledge amongst the public to push terrible investment products with high MER’s on them. This CBC article does a great job of showing with hidden cameras showing how bad the service really is.
If at all possible, high MER’s should be avoided when choosing your mutual fund or ETF. Indexing is a great way to match the return of a benchmark index (like the S&P 500), tends to be less expensive, and historically blows away the actively managed competition. I hope this article was a good read! If you have any questions feel free to put them in the comment box and I’ll get back to you as soon as I can. Good luck!
-ThePokerCapitalist
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