April 12, 2017 – It’s funny how so many people are bargain hunters when it comes to cars, clothes, appliances and various other largish expense items, yet not in regard to investment products. It seems people simply don’t think of their investments as having costs. They most certainly do.
A number of polls and studies over the years have demonstrated that many Canadians have no idea of how much their investment products cost. In fact, many people seem to have long thought that investments (and the associated advice given in buying them) are free – simply because they never get an invoice to pay whatever they might cost.
Please be assured. Investment products cost money – and the difference in cost can have a staggering impact on your wealth over time.
At issue here is not only how much various options cost, but also the value associated with each. Price is what you pay; value is what you get. Here’s a simple metaphor – cars. Let’s compare two automobiles – a 2017 Hyundai Santa Fe and a 2017 BMW 7 Series Sedan. The Santa Fe might retail for about $25,000; the BMW for $125,000. I doubt if anyone would suggest that these two options are “comparable” under normal circumstances – the first is an everyday sort of vehicle used by families for all manner of uses, while the second is a high-end luxury vehicle that is usually only purchased by corporate executives and the like. Most people would say the BMW is the “better vehicle” due to the wide array of bells and whistles and safety features. Ask people which vehicle represents the better value, however, and the answer often changes.
Let’s just move the decimal a bit to understand the impact of product cost on your nest egg. Many people who want to buy diversified investment vehicles often choose between mutual funds and exchange traded funds (ETFs). These products cost money. Comparing apples to apples (i.e. holding the cost of advice constant at $0) a basket of ETFs might cost 0.25% (like the Hyundai with the decimal moved over), whereas most F Class mutual funds might cost 1.25% (like the BMW with the decimal moved over). Do you see where this is going?
The obvious impact (that many less experienced investors often don’t think about) is that if nothing else changes, the lower cost product will generate a higher return – simply because it costs less! The phrase that many people in the investment industry use is: “you get what you don’t pay for”. As a result, investment products might be the only products in the world where higher quality might actually be associated with lower price.
Luxury products don’t always represent the best value. In fact, there are many people (myself included) who would rather use cheaper products because cost is widely viewed as the most reliable determinant of returns (the lowest cost products have the best returns because they are less of a drag on performance). Let’s use a simple example. Let’s say you have $500,000 to invest and you can choose either mutual funds or ETFs to do so. Whatever advice you use would cost the same either way. One costs 1% more, so it earns 1% less – let’s assume 5% and 6%. After 20 years, what’s the difference?
At 6% the final value is: $1,103,567.74; at 5%, the final value is: $826,648.85…. nearly $277,000! This ‘little’ 1% difference could easily cost a moderately wealthy Zoomer with $500,000 to invest at age 60 to have well over a quarter of a million dollars LESS to their name by the time they reach 90 (and many Zoomers will reach their 80th birthday).
My advice is to worry less about how much you’re paying for your shirts suits and dresses and considerably more about how much you’re paying for your investments. A seemingly small 1% difference can have an enormous impact.
John J. De Goey, CFP, CIM, FELLOW OF FPSC is a portfolio manager at Industrial Alliance Securities Inc. (IAS) and the author of The Professional Financial Advisor IV. The views expressed are not necessarily shared by IAS. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund.