A reader recently asked me a question about investing fees over a lifetime. I’ll cut to the chase first, but please see below for more colour on this conversation.

Q: What would the lifetime cost of investing be for a Canadian who consistently saved 10% of their income from age 25 until they retired at 65? Assume they live until 90.

First some caveats: There are many variables that factor into the answer here. I actually put together a spreadsheet for people to input their own particular variables in order to get a rough idea on what the answer might look like. Over 65 years of data, a small change in even one variable will lead to sometimes dramatically different answers. Many thanks to Michael James on Money for helping me put together the final spreadsheet. Before I continue, you should really follow him on Twitter, and check out his blog. Believe me, it’s worth it.

For this sample answer, I’ve used the following assumptions:

1. Income at age 25 starts at \$25,000 and increases at a nominal rate of 5% for 20 years, then 3% for the next 20 years.
2. The annual savings rate is 10% for all 40 years.
3. He starts out as an aggressive investor for the first 20 years, pares back on risk for the next 20, and then becomes even more conservative throughout retirement. The benchmark (before fees) for these three phases are 8%, 6%, and 4% respectively, before inflation.
4. Inflation increases over time. 1% for the first 20 years, 2% for the next 20 years, and 3% throughout retirement.
5. Portfolio costs are 2.25% per year for the first 20 years, decrease to 2.00% for the next 20, and reduce to 1.75% in retirement. This would reflect a lower risk tolerance over time (costs tend to decrease as allocation to fixed income goes up), as well as the ability to get lower fees with a larger portfolio over time.
So what are the lifetime investing fees for this fella?

With the above assumptions, this investor would pay \$170,578.27 in today’s dollars over their lifetime in investing fees (not including annual account fees or other expenses).

• On a non-inflation adjusted basis, or nominal terms, that is equivalent to \$306,713.19.
• If you take the same variables and reduce the costs to be in line with working with an advisor who uses a couch potato portfolio with you, the annual costs may approach 1.25% (cost of advice plus lower cost of product). In that case the lifetime costs, with all other variables being equal, is \$40,341.01 less (inflation adjusted), for a total of \$130,237.25. The annual income in retirement increases by 27%, and the total income in retirement from age 65-90 increases by \$77,526.77 (these are also all inflation adjusted figures).
• Since I’m sure some people would be curious, a completely DIY portfolio at 0.25% cost would only cost \$32,142.92 over the lifetime, a reduction of \$138,435.35, or 81%. The annual income in retirement would increase from \$11,342.57 to \$20,525.04 per year, and the total income withdrawn in retirement would increase by a whopping \$229,561.81 in today’s dollars (or \$604,002.34 before inflation).
Click to enlarge screenshot:

I’ve written fairly extensively about fees on this blog, in my columns at The Globe and Mail, and also for MoneySense Magazine. To put it bluntly, the impact of fees should not be dismissed, but if you have that conversation you need to talk about  behavioural costs and practical limitations, and you also need to keep in mind that the audience who finds this stuff interesting represent a minority of the overall population. I don’t want to give people the impression that the primary goal for an investor is to minimize fees at all costs (no pun intended) and then see those people end up doing more damage to their nest egg than they were trying to save in costs.

Over the next few posts (which may take weeks given how often I write to this blog these days), I’ll tackle the lifetime costs of investing from a variety of angles including:

• You can lower your costs while still using a professional advisor
• The behavioural costs compared to direct portfolio costs (the former can easily be larger than the latter)
• How advisors can earn more by lowering costs for their clients
• And more

If you would like to download a copy of the spreadsheet to play with, you can do so here.

Preet Banerjee
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• Michael James

That’s a nicely laid out spreadsheet. I was imagining a last line saying age 90 and finding it somewhat ominous, but after scrolling down I saw “dead”. That’s pretty clear.

• Preet

Perhaps the next iteration of the spreadsheet will hold retirement income steady, and calculate when the money runs out in both scenarios. I’ll label the output as “Hopefully you’ll be dead by age:”.

• Excellent post, Preet. What do you think of the argument that the interests of financial advisors are aligned with investors in terms of fees? i.e. the better the investment does, the higher the dollar amount of fees (2.5% MER brings in more dollars to the advisor if your portfolio goes up to \$12,000, as opposed to if it stays at \$10,000). Isn’t that incentive for advisors to ensure your investments do well?

• Preet

Actually, lower annual fees will lead to more income for the advisor over time. I’ll explain in a future post, but essentially, the portfolio is so much bigger down the road due to the lower fee drag that the advisor can earn substantially more. This works if they focus on reducing the product cost, and even (to a lesser extent) if they drop their cut. Ironically, with respect to performance, the best predictor of that is low cost.

• Kyle @ Young and Thrifty

Now that is a really interesting point I hadn’t considered Preet. You need to start doing this blogging thing again!

• Richard

It’s much easier to find more clients who don’t know what performance they’re getting than to find better performing investments (even for advisers who have the extra resources from higher fees). Typical results reflect this incentive. Preet’s comment might hint at why mutual funds with lower fees tend to have better performance even though they have the best reason to charge more.

• Preet

To help figure out your performance, I’ll shamelessly promote this piece I wrote for MoneySense: http://www.moneysense.ca/invest/how-you-doin

• Richard

Another incentive is pretty clear: an adviser that collects twice the fees (at a percentage) only has to work half as hard to get their desired level of income. There are countless examples that show that in the investment industry, you often get what you don’t pay for. The advisers who provide good service to their clients should earn a good income from it, but when it’s a one-sided deal we know very well that there is not much incentive.

• Preet

While I’m on a roll, I’l plug this piece, also from MoneySense, which addresses the income over time versus workload per client over time. It’s a front end investment by the advisor which can turn into quite a cash cow for little work down the road: http://www.moneysense.ca/invest/find-the-perfect-financial-planner

Transparency, candour, and professionalism is not as ubiquitous as we would expect or hope.

• Helen_in_Toronto

Hi: I’m really looking forward to the explanation: “Actually, lower annual fees will lead to more income for the advisor over time”.

• Preet

Thanks Helen – I hope to get a chance to write it this weekend.

• Peter

Can you clarify whether the fees calculated are on the whole portfolio or just the investment gains? i.e. the investment of \$2500 with 8% return grows to \$2700 and a fee of 2.25% on the whole portfolio is \$60.75 but on just the gain of \$200 the fee is \$4.50. It’s my understanding that the MER is based on the investment gains.

Fees will always be on the whole portfolio. If an your portfolio returned no gains, do you think you’re advisor is still going to get paid (yes…yes he will)? Better yet, if your portfolio returns an annual loss, do you think you’re advisor is going to pay you?

• Preet

Adam is correct: the fees are based on the overall balance for mutual funds in Canada. Rarely are there any exceptions to this rule (notably hedge funds, which are a separate type of managed fund).

• The golf guy

Hi , understanding how fee’s work is very important and most advisors should disclose how they get paid. realizing that the MER goes to the Fund company not the advisor, and the advisor is paid a trailer from .5% -1.25% from the fund company annually based upon what fund and the asset class it is in. It is in the both parties best interest to manage the portfolio for growth. The client isnt paying the advisor the fund company is. In a fee for service arrangment you and the advisor decide how much they are worth. Easy Math, best scenario for an advisor on \$100,000 is \$1250/year, not deducted from fund return and usually a portion of that goes to the firm .

• David McDonald CFP

What kind of investing are we talking about here? Stocks and shares or mutual funds or segregated funds. If stocks and shares are we discussing trading through a stock broker or a discount brokerage? If mutual funds are we discussing working with an independent advisor who is fee-based or one who works on a front-end fee basis or deferred sales charges? Or is the discussion about using ETFs? Or ….. there are so may variables.

• Preet

You can model that with the spreadsheet. In the particular example above, scenario A was with mutual funds with embedded compensation. The scenario with costs of 0.25% was for a DIY portfolio of index ETFs.

It does not take into account taxes, registered vs non-registered accounts, or deductibility of client advisory fees.

I discuss some considerations in future posts, as you are right: there are many variables to consider, both from a practical and psychological point of view (among others).

• Blair

When do we see a spreadsheet that says if you invest this amount of money and get 7% a year you’ll retire with this??

• Preet

I’m not too sure what you are asking. There is already a spreadsheet provided (you can click on the link to download it – it is at the bottom of the post). Did you mean something else?

I would question the value of this exercise, as there are too many variables. It is more sensational than practical and assumes that the lower the cost the better, which is not necessarily so . More important than price is actual performance. If I can obtain a 6% increase per year, after fees, on my portfolio from year to year I don’t really care how it was achieved as long as the portfolio reflects my risk profile. Also, the portfolio costs used in the illustration are excessive based on what is currently available on the market, and the inflation figures used are somewhat meaningless. This article will be interesting and entertaining to those with a low level of investment knowledge. Don’t let price be the driver of your portfolio , or you may get what you pay for and end up in the ditch, when you thought you were on the road to your destination.

• Richard

Even if you only care about a 6% return, a portfolio that gives you that return after a 3% fee will look very different from one that gives you the same return after a 0.3% fee. The portfolio with higher fees has to take on higher risks just to give you the same returns. Those fees may be buying nothing more than “return-free risks”. That’s not something I would want at any price.

Richard, you are making too many assumptions. A portfolio with higher fees does not necessarily mean higher risk. Also 3% fees are next to being non-existant in the mutual fund industry (aside possibly from insurance backed segregated funds)

• Kyle @ Young and Thrifty

Actually Fred, when it comes to mutual funds specifically (by far the most popular investing mechanism in Canada) there is definitely academic proof that shows there is an inverse correlation between the size of the MER and the performance of the fund over the long term. To make your position true, one would have the assume the premise that somebody out there can predict the mutual funds that will outperform their benchmark over the long term. I assume you have data that shows it’s possible to pick mutual fund winners 20+ years before they happen?

Kyle, All I am saying is that you should not make choices solely based on fees. Given two Balanced Funds, as an example, A and B where Fund A has a 10 year history of averaging 9% with low volatility and tenured management, I would choose it over B, even though it has an MER of 2.% versus Fund B which has an MER of 1.4%, an average of 6%, higher volatility and a management team that has only been in place for 2 years. There are reasons to go with a higher MER in some cases.

Kyle,
Could you also provide a link to the research that shows a correlation between low fees and fund performance. Thanks

• Steve

Hardly a sensation exercise:
-lower costs have been empirically shown to be better, active or passive
-costs uses in example are industry standard, in fact many funds cost a lot more than numbers used
-inflation being useless: guess that’s why you can pick inflation-adjusted or non inflation adjusted numbers, or input your own
-I think the only one with low level investment knowledge is you based on your comments
-always nice to end with a good sales analogy to scare people re: car and ditch. sheesh

Steve, See my comment to Kyle above

• Keith Worrall

How can I use your spreadsheet to do an estimate of costs from a retirement age with a certain amount invested, withdrawal rates and so on?

• Preet

Hi Keith, you have two options:

1. For full flexibility you can unprotect the sheet (there is no password required, just find the option to “unprotect worksheet”) and then make any modifications you like.

2. For a quick answer you can simply set the fees, benchmark return, and inflation to zero for the accumulation phase, and set the contributions to add up to the portfolio value you want at retirement. For example if you wanted a balance of \$400,000 at age 65, you could enter a starting income of \$10,000 with a contribution rate of 100% and income growth rate of 0. 40 years of \$10,000 gives you your \$400,000. Then, for the 65+ phase, you can set the annual fee, benchmark return, and inflation as you wish to get an answer. Note that the spreadsheet automatically calculates for a fixed (inflation adjusted) withdrawal that will lead you to a zero balance at age 90.

• Keith Worrall

Thank you. I will give it a go.