Management fees: The hidden impact

PORTFOLIO DOCTORS They can cost you plenty over time, say David Cruise, Alison Griffiths

e adore financial professionals

who want to lower fees. Matthew and Sandra B.’ s adviser is suggesting they consolidate their three accounts, under his supervision, in order to reduce investment costs.

However, before our patients go flinging all their hard- earned savings at this adviser, they need to do a little digging and a little contemplation. Though Matthew and Sandra readily admit they have limited investment knowledge, they have squirreled away $390,000 during their working life. That earns them one very big gold star. But because they don’t know a lot about investing, it behooves them to move very slowly and carefully.

Since our patients’ only retirement income, beyond CPP and OAS, will be Sandra’s prospective pension of $500 a month, capital preservation should be one of their top goals. Their house is paid for, they are thrifty and they already have a nice nest egg. No need to take on too much risk. Matthew and Sandra’s adviser makes a compelling point about fees. Mutual fund fees, in the form of the management expense ratio ( MER), can take a big bite out of their return. Add in sales commissions in the form of front-end loads or deferred sales charges and returns are reduced even further. Even deferred sales charges ( DSCs) cut into return by discouraging individuals from switching out of poor performing or expensive funds. Gains that could be earned elsewhere are given up in favour of a bad fund that is carrying a DSC. That’s called investment opportunity cost.

Here’s an eye opening, fee- impact example. Say Matthew and Sandra put

W$ 10,000 into Extreme Canadian Equity fund, which has a 2.75 per cent MER. Then they take another $ 10,000 and plop it into Frugal Far North Equity fund, which has a 2 per cent MER.

After 10 years, let’s assume that both funds have enjoyed an 8 per cent average annual return. According to the www. investorEd. ca fee calculator ( click on Investing Basics then look for the Mutual Fund Fee Impact Calculator link), once we take the MER into account, at the end of 10 years, Extreme Canadian Equity has grown to $16,507.44. The profit after fees is $ 6,507.44. A little over $ 3,620 has gone to management fees and a further $ 1,460.94 has vanished in the form of lost profits. The latter refers to the money that would have been made if the money that went to fees had been invested instead.

In comparison, Frugal Far North, with a 2 per cent MER, has grown to $17,773.78, for a profit of $7,773.78. That’s a difference of $ 1,266.34 — a large chunk of money that would otherwise go into an investor’s pocket.

We’re only dealing with $ 10,000 over 10 years here. If our patients continue to invest new savings plus the $ 390,000 they now have for a further decade before retirement, fees will make a significant difference to their return. If the same 0.75 MER gap is carried over to the rest of their investments, that’s a loss of more than $ 45,000 over 10 years.

( Another useful fee calculator can be found on www. iunits. com.) Lower fees are one reason why many of the experts we work with recommend that individuals with assets of over $ 250,000 move into stocks and bonds rather than equity and bond or fixed-income mutual funds. Wealth managers typically charge from 1.25 to 1.5 per cent of assets under management for a portfolio of our patients’ size.

Since the main goal of consolidating Matthew and Sandra’s accounts is to reduce fees, the first step is to find out what they are paying now, both to their adviser and to invest in the Clarica and Royal Bank funds. It is all very well to have someone claim to reduce costs, but if they don’t know current fees then any comparison is useless. Matthew and Sandra need to come up with an average percentage fee for their various accounts. But, because their funds are held in different proportion in their portfolios, each fund’s MER will have to be weighted accordingly. The calculation isn’t too taxing. First determine what percentage of the overall holding a given fund is, then multiply the fund’s MER by that percentage. Finally, add the totals to get the weighted MER. The fund companies can provide the MER, or it is available at www. morningstar. ca. We can hear the mathematically challenged groaning mightily at the thought of all this arithmetic. Certainly, Matthew and Sandra’s adviser can help with the math ( though don’t forget, he has a vested interest in them consolidating). Some of the funds Matthew and Sandra currently hold may have been bought on a deferred- sales- charge basis. A call to the fund company will also tell them what they will have to pay if the DSC schedule has not yet expired, usually six years after purchasing a fund.

Current fees are only the first step on the road to a decision about how to handle their portfolio in the future. Next week, questions to ask their adviser before making any moves. Send portfolio, comments or questions to Portfolio Doctor, Business, Toronto Star, One Yonge St., Toronto, M5E 1E6; email theportfoliodoc@ Web at www.portfoliodoctor.ca.