Fees, Fees, More Fees

Fees and expenses have been shown to be the most consistent and reliable predictor of a fund’s net performance. The higher the fees, the worse the performance. In Morningstar’s 2015 global study[3] of fund investors in 25 developed and developing countries, Canada ranked last with a D− rating. Canada’s fees and expenses were highest (or tied) in all but one category, money market (second highest). The US, Australia and The Netherlands topped the survey, each with a ranking of A.

Low investment management fees are critical to long-term investment success. To see why this is true, we start with investment return expectations for the future. Experts generally agree that a balanced portfolio of stocks and bonds can be expected to return about 5-7% (with about 2% inflation) going forward; this is slightly more than half of what returns have been historically; and is primarily due to the very low return expectation for bonds, which are exhibiting historically low yields in most of the world.

Combine this with the fact that many investors are subjected to fees of 2% or more on an annual basis[4], and we can see why a major disconnect is forming between investor expectations and the conflicting interests of the investment industry. Using the above estimates, the 2% in fees represents 28-40% of the expected return. Think about that for a minute. Regardless of how poorly the manager performs relative to her objective, she will take up to 40% of the total nominal return on the portfolio. That’s not all. The taxman will take a big slice of the remainder[5]; and inflation will take most of the rest of the pie, as it eats into the purchasing power of investors. What you have left, you can spend. Of course, HST will reduce your “investment” proceeds by another 13%. When we look at it like this, it’s not hard to understand why people struggle to save for retirement. What at first blush seemed manageable – a 5-7% nominal return with 2% inflation – becomes a very punishing prognosis; a prolonged period of flat or negative real returns for investors.

What can we do about it? We as investors cannot control the market return. Nor can we control inflation. We can control taxes to some extent – and we can defer them. But mostly, we can control one of the biggest drags on our returns – the fees we pay.

[3] Morningstar – Global Fund Investor Experience Study June 2015
[4] Incl. asset-based fees, sales loads, mutual fund commissions, trailer fees, trading and foreign exchange charges.
[5] This analysis assumes a taxable account. For RRSPs, the tax impact is felt when the money is withdrawn.

“The greatest Enemies of the Equity investor are Expenses and Emotions”.
– John C. Bogle, The Little Book of Common Sense Investing