Fees –the threat to retirement income security
It’s generally well known that investment fees are the silent killer of returns. Fees are inevitable since professionals who provide financial services need to be compensated for their work. The goal for a senior is to obtain the needed services at the lowest cost.
Investment fees are one of the most important determinants of investment performance and are something on which every investor should focus. Over time, minimizing fees tends to maximize performance. Mutual funds are the most popular investment product for Canadians yet empirical research has shown that Canadian mutual funds are among the most expensive compared to other countries.
Fees erode returns through the process of de-compounding. Every dollar spent on fees is a dollar that is not available for compounding. A person saving for retirement could be severely impacted by unduly high product and service fees. Even a 1% fee can have a material impact over time. See the fee impact calculator.
Of course, some fees are outright exploitive. For years, investors who owned mutual funds at a discount had embedded trailing commissions for personalized advice — but discount brokers are not permitted to provide personalized advice, so investors paid 1% for no benefit. Discount brokers are no longer permitted to charge such commissions. In other cases, investors in fee- based accounts can be charged an advice fee but if you own a mutual fund in the account, you will also be paying an additional 1% trailing commission embedded in the fund fee structure. This double-billing dramatically erodes retirement savings.
A number of Dealers carry only proprietary products so their advisors cannot offer you the choice of cost – competitive products.
Fees during de-accumulation phase
The issue of excessive fees is amplified during retirement where income comes from company pensions (if any), CPP/ QPP and personal savings and not from employment. Fees and costs are always important, but when money is being withdrawn from retirement savings they become critically significant. It is these accumulated personal savings that need to be protected from high fees since the average Canadian can live for 20 or more years after retirement. While spending on food, entertainment, and transportation remains relatively stable in retirement, spending on housing tends to go down while spending on health care and support services goes up. One of the biggest fears for a retiree is outliving savings aka longevity risk.
“Withdrawing funds regularly makes fee control more important. Take a $100,000 portfolio, assuming a 6% annual return and 2% in fees. After 20 years, with no withdrawals, the portfolio grows to $320,714 before fees. Fees take $106,603, or 33% of accumulated capital. Now assume a $4,000 annual withdrawal rate. The portfolio grows to $164,743 before fees but $91,106 after fees. Fees take 44% of the portfolio’s value. For those who live five more years, 55% is consumed by fees.”- Mark Yamada, Why fees become more important during decumulation.
What can you do to control fees?
Take time to understand exactly what fees you’re paying and what you’re receiving in return. Review investment prospectuses and fee disclosure documents, and compare the fees of various low-cost investment vehicles, such as index funds and exchange-traded funds (ETFs). Make sure the fees you’re paying for a given investment are justified by the returns you’re making and services provided.
- Make sure you have a frank discussion with your advisor on all fees you pay and how they are charged;
- Ask about lower fees available for larger account sizes ;
- Check to see if you qualify for a lower fee class of mutual fund;
- Ensure you are not being double-billed via embedded trailing commissions ;
- Shop around, negotiate the fee schedule;
- Consider engaging a fee-based with clarity of services to be provided;
- If you are confident in your investment knowledge, consider using a discount broker, avoid frequent trading ;
- Consider using low-cost ETF’s in lieu of actively- managed mutual funds ( it has been demonstrated that mutual funds rarely beat market indices over time, after fees) and
- Keep trading costs and frequency low.
Every year you will receive a Charges and Compensation report from your dealer which provides important information on the amount of fees you paid to the dealer in the year. Make sure you review and understand this report and don’t be shy discussing any questions or concerns you may have with your advisor. For more information on the Charges and Compensation Report visit Annual information about your investment fees . Are you getting value for money?
Bottom line
Professional advice can help keep costs in line but be aware that the majority of advisors in Canada are not fiduciaries. Most are compensated via trading/ trailing commissions and are subject to conflicts-of-interest. No one cares more about your financial health than you do. Put in the effort to control investment fees. The payoff is a better, peaceful retirement.
-Written by Ken Kivenco
