In today’s cost-conscious world we’re inundated with messages about the lowest costs, the easiest options for convenience and the best value. Unless you have a background in finance, the investment industry can seem like a cloudy maze difficult to navigate. We’ve kept our eye on the markets, the news, and most importantly, investments. Here are the top 5 things you should know about investment fees:
Fees have long-term costs that impact investments
A few percentage points in fees on your portfolio don’t sound like a lot. Time, however, is key to investments bringing in returns and making money. That same factor, time, is also what compounds those few percentage points and turns fees into major obstacles to long-term investment success.
Take for example a $100,000 investment over 20 years with a 4% annual return. A 1% annual fee, after 20 years can reduce your portfolio value by $30,000. Even a 0.5% fee will reduce your portfolio’s value by $10,000. Be sure you understand and compare the fees charged. They can save, or take, a lot of money in the long run.
Investment fees will impact financial goals
Don’t get influenced by constant ETF messages that claim they are the cheapest and best investment option. Just because the ETF fees (Equity ETFs on average charge 0.32%) are on the lower end, does not mean they’re the best option for your goals.
For example, the construction of ETF portfolios are designed to simply mirror and not to beat the benchmark meaning the odds for gaining above average returns are slim. Save your money, shop around, and consider investment options with similarly low fees that are designed to outperform the benchmark and make you money.
As an example, we have changed the fee structure of our Provisus Pooled Funds to be, what we consider, the most client-friendly fee structure in Canada. We charge some of the lowest base fees in the country (0.25% with a performance fee) and our portfolio management is designed to actively try to beat the benchmark for potentially higher returns on your money.
Low fee investments aren’t always the best option
Don’t be fooled. Lately, there is a discourse pushing the belief that anything getting in the way of the lowest possible fees is not worthwhile. This type of thinking aligns with the emergence of robo-advisors and ETF popularity, which have done successful marketing in positioning themselves as the cheapest, best option for investments.
However, digging deeper to look at the stats and yearly performance can result in a different perspective. When you want to make money in the long- term, this is not the best option (not even close). Firstly, robo-advisors on average charge 0.63% and, because of their programmed algorithm, there is a focus on passive investment options such as ETFs. It may look like this is a great option, right? Low fees, low-risk, easy investments. But there’s a reason this option is so easy. They’re not designed to make high returns. When you calculate the impact of the fees long-term, along with the opportunity cost of potential returns, your money and time is not well spent.
There are always hidden fees
Just because the listed fee price is what you see, it doesn’t mean that’s always what you get. Most investors have no idea that additional costs are coming out of their pocket. Certain costs are part of the total expense ratio (TER). The TER is a measure of the total costs associated with managing and operating an investment fund, such as a mutual fund. These costs can consist of operational costs like trading fees, legal fees, auditor fees and even marketing fees (to attract other shareholders to the fund).
One of the most detrimental hidden cost is based on lack of performance. For example, investing in an ETF (rather than an actively managed option) will likely not beat any stock market benchmark. The tracking difference is the difference between the results and the returns that could have made investing in a better option. This difference is a loss and one of the most misunderstood hidden cost within investment choices.
Taxes affect investment fees
Investments are no exception to the rule of taxation in Canada. There is a different rate of tax on investments, depending on the province. All investments in non-registered accounts are subject to tax, whereas registered investments are either tax-free (TFSA) or tax-deferred (RRSP), meaning you pay taxes upon withdrawal, giving you more money in your pocket.
As an investor with an open account, you’ll pay taxes on interest-bearing investments, dividend-paying investments, capital gains, and foreign investments. How much tax you pay depends on 4 things: the type of investment you made, the tax laws where you live, if your investments are in a tax-sheltered plan, and your income. Talk to a professional tax advisor to find out how taxation is affecting your investments and how you can manage your choices to pay the least tax possible.
When it comes to fees, shop around. Cheap isn’t always cheap. It’s important to know the affordable options out there, but knowing when to go cheap and when to take on more risk comes with time. Consulting an experienced professional can help to understand exactly what types of fees you are paying and how they will affect future investments. Ask questions and don’t be afraid to compare options.