Consider two Canadians saving for retirement. Both are clients of the same big bank (in our example it is RBC but it could be any of them). Each has built up $50,000 in RRSP savings over the past several years and each is ready to make a fresh $10,000 RRSP contribution.
Here is what Client A does.
He goes to his nearby RBC branch and meets with his advisor. After discussing his long-term objectives, risk tolerance, etc., the advisor recommends Canada’s largest stock mutual fund, the RBC Canadian Dividend Fund. As represented by its management expense ratio, or “MER”, this fund charges 1.76% annually in fees and other costs.
The fund’s largest stock holding include some very familiar Canadian companies. Here are eight of the top 10 stocks held by the RBC Canadian Dividend Fund, as of the end of October:
|Enbridge||Bank of Montreal|
Now for Client B.
She is comfortable investing without advice. By investing through her online RBC Direct Investing RRSP account, Client B has access to lower-cost investment alternatives. She buys the Vanguard FTSE Canada Index ETF which charges annual fees of 0.05%. Like mutual funds, index ETFs hold a portfolio of stocks (or bonds) on behalf of investors.
Thing is, the stock holdings of some index ETF portfolios look a lot like some mutual fund portfolios. In this case, the exact same eight stocks that are among the top 10 holdings of the RBC Canadian Dividend Fund are also among the top 10 stocks in the Vanguard FTSE Canada Index ETF*.
Now, there are differences between these two funds and Client A may value the advice he gets from his RBC advisor. But, buying the RBC mutual fund, he is paying 35 times as much for a fund with stock holdings similar to that obtained by Client B.
How will this fee differential impact the ultimate results experienced by Client A and Client B? Of course, we can’t predict future performance of mutual funds, ETFs or the stock market overall. But let’s assume both the RBC mutual fund and the Vanguard ETF produce an identical 6% average compound annual return before fees over 25 years.
The result is a pre-fee total gain on the original $10,000 investment over 25 years of $32,919 for both funds. But Client A will retain only $18,240 or 55% of that total return. His 1.76% in annual fees will consume 45% of his total return over 25 years. On the other hand, by paying only 0.05% in annual fees, Client B will get to keep 98%, or $32,415 of her total return. (If you wish to use your own assumptions to compare these two funds or to see how fees may impact your own ultimate investment returns, go to wealthgame.ca. (Self disclosure, this is my website.)
Does this strike you as ironic? By following advice, Client A ends up with a fraction of the gain earned by Client B who doesn’t seek advice. By investing through bank, insurance and fund company advisors offering only high cost mutual funds, millions of Canadians are in the same boat as Client A.
This illustration highlights urgent challenges faced by both Canadians saving for retirement and the financial industry which serves them.
How can Canadians minimize investment costs when most advice is offered only in combination with high-cost products? As Warren Buffett famously declared “The best investment you can make is in yourself.” A growing number of investors are learning investment basics and, like Client B, are investing in lowcost ETFs through online discount brokerage services. Others are taking advantage of “robo-advisors” who construct ETF portfolios matching client profiles at a cost lower than traditional industry providers.
What about the investment industry? Big Bay Street institutions continue to primarily rely on products whose fees consume much too large a share of Canadian retirement account balances. Canadians deserve better.
How can the investment industry best serve Canadians? The industry is currently providing more efficient alternatives for investors who seek them out. The big banks offer very efficient, low cost services through online discount brokers. Also, banks and other traditional industry players are investing in or developing their own “robo-advisors”. For example, the launch of RBC’s forthcoming InvestEase “rob-advisor” was recently announced. But more must be done.
Simply put, the financial industry must find new ways to much more broadly deliver a combination of needed advice and low cost products which leave more retirement dollars in the pockets of their customers.
Larry Bates is a former banker and founder of The Wealth Game
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