Investors must never lose sight of the true bottom line
You’ve found the fridge you want on sale for $999. It’s a bit of a stretch, but it’s the right size and has all the features you were looking for.
The salesperson, happy to be earning a commission, writes up the bill. You look at it and your jaw drops: $1,128.87. Adding on the sales tax has pushed the cost well over what you were planning to spend.
It’s just another reminder that when it comes to money, it’s all about the bottom line. The sticker price is irrelevant. All that matters is the amount you actually have to pay — or earn.
Investors would do well to remember this. Don’t get hung up on nominal returns or fees. It’s how much you keep in your pocket that matters. Here are three areas where people sometimes lose sight of the true bottom line. Fees We’re constantly reading about how high fees diminish returns and that’s true, up to a point. But what you really need to consider is value for money: what benefit are you receiving for what you pay?
For example, many people are choosing exchange-traded funds (ETFs) over mutual funds these days. One of the main reasons is cost: the management expense ratio (MER) is much higher on a mutual fund than on an ETF. But does that lower cost always translate into a higher return? No, it does not.
Consider the iShares Core S&P/TSX Capped Composite Index ETF. It’s incredibly popular with investors, with almost $3.6 billion under management. One of the reasons is its very low MER of only 0.06 per cent. They’re almost managing your money for free. But what are you getting for that small outlay?
According to the Blackrock Canada website, the ETF generated an average annual gain of 3.9 per cent over the decade to Sept. 30.
That’s not bad over that time frame, but there were several mutual funds with a much higher MER that beat that mark. The Beutel Goodman Canadian Equity Fund has an MER of 1.39 per cent (D units). Despite that handicap, it returned an average of just under 6 per cent annually over the same period — more than two percentage points better.
The Mawer Canadian Equity fund, with an MER of 1.19 per cent, did even better with an average annual return of 7.5 per cent. For fee-based accounts, the Fidelity True North Class F units have an MER of 1.14 per cent and an average annual 10-year return of 5 per cent.
This is not to say the iShares ETF is a bad choice. It did better than the majority of mutual funds in the Canadian Equity category. But you could have done better. The lowest cost does not always mean the best returns. Taxes A buck is not a buck when it comes to investment income. It all depends on where and how you invest. For example, any income earned in a Tax-Free Savings Account is all yours to keep. The government doesn’t get a cent. Investment profits in an RRSP, RRIF or RESP are tax-sheltered until they are withdrawn.
But the tax folks will pounce on any money earned in a non-registered account. That’s where you really need to be careful with your choice of securities.
Suppose you have a taxable income of $60,000 and you keep some money in an account with EQ Bank. Right now, you’ll earn 2.3 per cent on your cash. You’ll pay the government almost $3 of every $10 you earn on that account according to the EY 2017 Personal Tax Calculator.
But if you invested your money in a dividend-paying stock, your tax rate would only be about $0.75 on every $10 earned. And if your income were $45,000 or less you would pay no tax at all on dividends. Inflation The current rate of inflation in Canada is 1.4 per cent. That may not seem like a lot, but with interest rates so low it will take a big bite out of the purchasing power of any money earned in a bank account or GIC.
Suppose, for example, you invested in a five-year GIC with Oaken Financial, a subsidiary of Home Capital. The current quoted rate is 2.75 per cent, one of the best around. But that’s the nominal return.
Once you factor in inflation, you are left with only 1.35 per cent. The cost of living increase has stripped out more than half your purchasing power and that’s before the government has levied any taxes.
In short, you need to look at the whole picture when making investment decisions. Forget about fees or top-line returns. All that counts is what’s left for you at the end of the day. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.