Mutual Fund Fees Over 25 Years… Ouch
I put together a spreadsheet that will help people really quantify the effect of fees on a mutual fund over a long period of time for investors. It also shows you exactly how those fees are divvied up between your financial advisor, his or her dealer and the mutual fund company. You can make a side by side comparison of two different scenarios so you can see a fully advised, actively managed option versus a DIY, couch potato option, and everything in between. Here’s a screen shot (or download the spreadsheet here: The Real Impact of Fees on Most Mutual Fund Investors):
Over 90% of contributions consumed by fees?
In this particular example, a 2.69% MER mutual fund consumed 92.53% of your original contribution over 25 years and left you with 49.42% less money due to the effect of fees. Now, keep in mind you won’t be able to eliminate fees completely so comparing this to a 0% fee option is best used for comparison’s sake. For example, a 1.53% fee option still consumed 31.99% of your “potential” portfolio. However, you would’ve been almost $60,000 richer after 25 years and an initial $100,000 contribution. You also saved over $30,000 in fees. Now you see why DIY couch potatoes are so adamant about low costs. Download the spreadsheet and plug in a couch potato MER of 0.25% – 0.40% and see the effect. Yikes.
Of course, as I’ll mention below, saving 1% by firing your financial advisor can cost you more than 1% in performance and bad financial planning decisions. The majority of people still need an advisor for asset allocation, discipline and financial planning (insurance, estate, tax planning etc.).
MERQ – Management Expense Ratio per Quarter century
The numbers chosen were based on the Canadian Capitalist’s recent post in which he suggested that investors can retain a financial advisor and lower costs by using a financial advisor who uses cheaper funds with similar mandates. (Many financial advisors today are using passive portfolios and focusing more on the financial planning.) Specifically he compared a fund with a 2.69% MER versus a commensurate iShare exchange-traded fund (ETF) with a 0.53% MER and then added a 1% annual financial advisor fee to make a fair comparison.
Michael James on Money had a great post on a hypothetical metric that would emphasize the parasitic drain of Management Expense Ratios over time, something he called the MERQ – or Management Expense Ratio per Quarter century. Using the Canadian Capitalist’s example of a fund at 2.69% versus a 1.53% solution, the MERQs were 49% and 32% respectively. You’ll see the same results in this spreadsheet, but with the additional ability to plug in specific dollar amounts and to also factor in annual contributions as well.
The above posts were all sparked by Jonathan Chevreau’s recent commentary on financial literacy as it relates to financial services profits. To put it gently, it kinda exploded after that.
I agree that fees are extremely important, but there is more to the entire conversation than just that. Recently Dan Hallett, Director of Asset Management at HighView Financial Group added his two cents in a piece called Mutual fund critics missing the big picture. More and more, investors and financial advisors alike are beginning to believe that the true value add from an advisor is the financial planning.
Watch this space…
Right now, the calculator assumes that the financial advisor chooses only to use a Fee-based model or use a Front-End mutual fund with a 0% upfront commission. In the real world, some financial advisors may use Deferred Sales Charge funds or Low-Load Funds as well. This will change the calculation of fees directed to the advisor and dealer. I’ll build the ability to differentiate between commission models in a future version of the calculator. This will include choosing a fee-only option as well.
I do want to point out what I think are some salient points:
- In the above example, the investor AND the advisor take home more money when product cost is reduced (all other things being equal). This is again because the lower cost reduces the drag on compounding returns. It’s win-win. Lower costs via indexing means lower revenue to the fundco’s, but index fund manufacturer’s know the game is a margin compression one in this space for the most part. 0.25% in revenue for a slice of the ever growing, big index fund pie potential is better than not adding any funds to an active fund with a management fee of 2% given the fund flows of late.
- Firing a financial advisor to save 1% in fees can end up costing you more than 1% annually if you don’t know what you are doing, or are missing out on financial planning strategies not related to your portfolio.
- There’s no reason you can’t get active management cheaper with a mutual fund if that’s your cup of tea.
- Transparency is the key take-home point – you should know where all your money goes and you should be able to talk to your advisor about it so that your decisions are more informed ones.
- Fees really matter
Download the spreadsheet
If you haven’t yet, download a copy of the Microsoft Excel spreadsheet here: The Real Impact of Fees on Most Mutual Fund Investors.