Focus on fees
Shortly after Erin Richard’s boyfriend got down on one knee and popped the big question last November, the public relations professional and her fiancé wisely had a frank discussion about money. But it wasn’t the typical talk that most twenty-somethings have, which usually revolves around whether or not to open a joint account, or how much one partner spends versus the other. Instead, the Toronto couple debated where they want to put their retirement savings: with a bank, or with one of Canada’s recently launched robo-advisors. The new automated digital advice services allow you to build a low-fee exchange-traded fund (ETF) portfolio, based on your risk tolerance and time horizon, through your computer screen.
At the moment, Erin, 29, has about $25,000 worth of GICs in an RRSP at her bank. But her soon-to-be hubby has all of his money with Wealthsimple, a Toronto-based robo-advisor, and he wants her to do the same. He argues he’s getting better returns than what he could get at the bank, in part because he pays a fraction of the fees that a traditional financial institution would charge.
While all of that sounds appealing, Erin’s not entirely sure if she should bet her retirement savings using early-stage technology. There’s something about a bank—the security, the trustworthiness, the access to its financial advisors—that’s reassuring to her. “It’s a point of contention between my partner and me,” Erin says. “But I don’t know enough about robo-advisors.”
What the experts say
On the surface, Erin’s issue seems like a choice between one firm over another based on the idea that she’ll receive more reliable service by purchasing mutual funds at one of the big banks. But that’s rarely the case, according to Jason Heath, an advice only, fee-for-service financial planner with Objective Financial Partners in Markham, Ont. Why? More often than not, these large firms do a poor job of servicing this age group, he says.
At the Big Five, Heath explains, young investors typically only get access to the most expensive and worst performing mutual funds. Because they don’t have enough money to get the fee reductions that higher net-worth individuals get, he says, most are just slotted into a balanced fund that may or may not perform up to the standards of more sophisticated investors. The robo-advisor, on the other hand, “provides a really low-cost and lean investment alternative, and that’s great for young people.”
For investors in their 20s, Heath says, the reality is that the performance of one fund over another is less important than what they’re paying in fees. Consider the cost of buying mutual funds in Canada, which, on average, come with a 2.5% management expense ratio (MER). By comparison, most robo-advisors charge a 0.5% fee, plus a much smaller MER on the actual fund. (For instance, the MER on the ETFs that Wealthsimple uses adds an additional 0.2% to their fee.)
Since compounding interest is the number one reason why advisors recommend saving for retirement early, the more money one can have compounding in an RRSP the better, says Heath. “The main thing about robo-advisors is not that they’re going to outperform other types of investments,” he says, explaining that these firms’ portfolios of ETFs generally match or track the components of a market index. “It’s the fees. Saving up to 2% is a big deal in today’s low interest rate environment.”
The other advantage to a robo-advisor is that it makes it extremely easy to save. While banks offer some of the same investing tools as robo-advisors—like automatic withdrawals and regular rebalancing—robo-advisors tend to have user interfaces which are more intuitive to young tech-savvy Canadians. With a press of a button, money can easily be moved into an RRSP. “That’s the really interesting opportunity for people in their 20s,” says Vickie Campbell, an advisor with Ottawa-based financial planning firm Ryan Lamontagne Inc. “It gets easier to be invested in the market and you get a good allocation.”
The downside of a robo-advisor is that it doesn’t offer financial planning advice. That may be an issue for some, but twenty-somethings don’t typically get good advice anyway, says Heath. Any fee-for-service planner will be too expensive for this cohort—most young adults can’t afford his fee (a $2,000 flat rate), Heath admits—and the fresh-out-of-school bank advisors who don’t have any experience aren’t much help either. Still, Heath thinks that robo-advisors will start offering advice at some point soon. “Hopefully that will bring more planning to the masses,” he says. “Even at the expense of guys like me.”
Whether you’re using a robo-advisor or traditional banking services, though, just be sure to remember that retirement is typically not the only savings goal young people have. Many will want to start saving money for a house or a car, and in that case a TFSA with assets in more conservative investments may be the better option over an RRSP, says Heath. So think of RRSPs more as long-term investments, but keep money for more immediate needs in a TFSA where it can grow tax-free but can also be removed without any tax hit. (Remember, RRSP withdrawals are almost always taxable income.)
Keep in mind, too, that if saving isn’t even on your radar right now, that’s OK. In your 20s, paying the rent and keeping up with your bills will likely eat up a lot of your income. There’s still plenty of decades ahead to focus on savings when your paycheques start getting a bit bigger. At the very least, just be sure you’re keeping on top of debt.