Episode 38: How Much Are Investment Fees Really Costing you?

Jun 28, 2023

By Kanwal Sarai

Under Retirement

29 min read

Simply Investing Dividend Podcast Episode 38 - How Much Are Investment Fees Really Costing You

Audio only version is available here, and on all your favorite podcast players. Transcript available here.

What if the key to unlocking your financial goals lay in understanding the true cost of investing? Brace yourself for a deep dive into the world of investment fees and their impact on your portfolio. I peel back the layers, demystifying the complex world of Management Expense Ratio (MER) fees that define mutual funds, index funds, and ETFs. I provide real-world examples illustrating the calculation of these fees, their cumulative impact on investment returns, and why they are even charged in the first place.

I cover the following topics in this episode:
- What is the MER fee?
- Why are you charged a fee?
- What is the true cost of fees to you?
- How can you eliminate fees?

Complete Transcript

Are you aware of the negative impact of fees on your investments? Even low-cost index funds or ETFs can end up costing you thousands of dollars. Hi, my name is Kanwal Sarai and welcome to the Simply Investing Dividend Podcast. In this episode, we're going to cover four topics. I'm going to start first with what is the MER fee. Next, i'm going to talk about why are you charged a fee, and then we are going to look at the true cost of fees to you and to your investments. And then we'll look at, lastly, our topic of how you can eliminate fees in your investment portfolio. So let's get started with the first one What is the MER fee? So the MER stands for Management Expense Ratio. So here are some typical MER fees.

01:08

Now, whether you have mutual funds or index funds or ETFs, they all carry fees and different types of fees. So let's take a look at some examples here. So mutual funds typically on average anywhere from 1.5% to 3% a year. So that is calculated on the value of your portfolio, and then every year, that amount is deducted from your portfolio, and we're going to see some examples of that later on. Now there are some mutual funds that charge more than 3%, 3.5%, maybe a little more than 3%, and there's mutual funds that charge less than 1.5%, but this is sort of the ballpark typical average fees And you can see that up on the screen here. Next, we look at index funds. So typically their fees are a little bit lower and they range anywhere from 1.5% a year to 1.5% a year, and again there's index funds that have fees that are slightly higher and fees that are slightly lower than that. And lastly, we have ETFs. These are exchange traded funds And they have fees which are a little bit lower, ranging anywhere from 0.03% to 1%, and again, some of them are harder than that, some of them are lower, but that's sort of the approximate ballpark average. Now, as you know, with any of these types of funds, what they do is, when you invest in it, they take your money and then they take money from other investors and they pull that money together and they turn around and they buy stocks with it. So I've heard people say they're afraid to invest in the stock market, they don't want to buy stocks, but then they happily turn around and invest their money in mutual funds, index funds or ETFs. So if you're doing any of those investments, you are indirectly buying stocks, because that's what these funds are doing. So the only difference here with the mutual funds typically will have a portfolio manager who's responsible for managing the investment. So this person decides what to buy, when to buy it, when to sell the stocks, and so they make those decisions.

03:30

An index fund does not have a portfolio manager. This is a fund that's not actively managed. An index fund will generally buy all of the stocks in the index. So if you have an SNMP 500 index fund, it is buying 500, there's 500 stocks in the index. It's buying all the stocks in that index. Right, a small piece of it, but it buys all the stocks in the index. So the only time an index fund is going to sell a stock or buy more is when a company in the index is removed and another company is added. Otherwise the funds going to hold that. Of course they're going to buy more as more investors put money into it, but otherwise they're going to hold on to the that bucket of stocks that are in there.

04:17

An ETF is an exchange traded fund. It's kind of like an index fund, but it's traded on the stock market as a stock, so it's much more liquid. You can buy and sell during, sort of, when the stock market's open, you can buy and sell immediately like you would with a stock, and the price changes like a stock. When you look up a stock quote, you can look up a price quote for an ETF and you can see what it's worth at any time, any day. But anyway, our focus for this episode is to talk about the fees. So you can see the fees listed up on the screen here.

04:56

I'm going to give you one more example. These are some real life examples. I just pulled some of these stocks just to take a look at them online. So, for example, the first one on the list is the BMO Global Small Cap Fund. Today this fund, as of this recording, has an annual MER fee of 2.59%. The next one up on the screen is the BMO US Dollar Equity Index Fund And you can see it has a fee of 0.98%. And then we have the Vanguard SNMP 500 ETF And again you can see the fee is 0.03%. So I'm not endorsing any funds here. I'm not recommending any of these funds. These are just shown as examples of actual funds And I just wanted to show you what the fees look like.

05:48

Now, keep in mind you don't pay the fee directly, ok. So we're not talking about a front-end fee or a back-end fee that you would pay to an advisor or to a mutual fund company. We're talking specifically about the management expense ratio, the MER fee. So you don't pay the fee directly. How it works is when you invest in the fund, they will automatically, at the end of the year, deduct that fee from your investment. So let's see what that looks like.

06:20

So here I'm going to give you an example of a SNMP 500 fund, and in this example let's assume that the MER is 2%. Ok, it might seem high to most of you, but for example, in Canada the average MER is 2.2%. So we'll stick with 2% here. So let's assume the annual fee is 2% And let's assume the stock market returned last year 5%. We're just making up a number here. The stock market goes up and down every year. Some years you get a positive return, some years it loses money and you get a negative return, and some years it just breaks even and you get a 0% return. So in this example, let's say the stock market returned 5%. So let's assume the SNMP 500, the 500 companies that are in this fund By the end of the year, after one year they had a total return of 5%, which is not bad. But if you were invested in this fund in this example, your return would be actually 3% And that's what your statement would show at the end of the year. It would say here's how much money you invested and here's how much money you have left over at the end of the year. And in this example it would say you had a return of 3%. So in fact, the market returned 5%, the company deducted its 2% fee and you were left with 3%. So let's see what that looks like when we put some real numbers behind it.

07:59

So, as an example, let's say you invested $100,000 in this fund. At the end of the year you would be left with the fund. The portfolio would be worth $103,000. So you started with $100,000 investment and you ended up with $103,000. That's a 3% return. So that's what you ended up with. However, if the fee was gone, if there was no fee, you actually would have been left with $105,000. So you can see here the cost was you lost out on $2,000. You would have made more money if there was no fee.

08:39

Now let's take a look at one more example. We're going to stick with the same SNMP 500 fund. We're going to stick with the same MER 2%. But in this example, let's say, the stock market didn't have a good year, didn't have a bad year, just the return was zero. So if you invested directly into the stock market with these 500 stocks, your return would be zero. However, with this fund and the fee of 2%, your statement at the end of the year would show that you actually lost money And it would show that your return for your investment was negative 2%. So how did that happen? So what they do is they take the stock market return, which was, in this case, 0%, and then they deduct their fee and you end up with negative 2%.

09:27

Now, if we put numbers to it, we're going to stick with the same example $100,000 invested with this negative 2%, your portfolio at the end of the year would be worth $98,000. So you lost money. You started with $100,000 investment and at the end of the year you're left with $98,000. That's because of the fee. If we remove the fee altogether in this example, let's say you took that $100,000 and you invested it directly. Well, if the stock market returned zero, you didn't lose any money. Your portfolio would still be worth $100,000.

10:06

So you can see what's happening here is the fund company gets paid every single year. Whether you make money or you lose money, the fund is going to deduct their fee. So when the market has a positive return, you make a little bit less because of the fee. When the market breaks even, you lose money because of the fee And if the market has a negative return, you lose a little bit more because of the fee. So either way, the company is going to get paid, they're going to deduct their fee and you as an investor are getting penalized for holding these funds.

10:50

But now let's take a look at our next topic Why are you even charged a fee? Like, why do mutual funds, index funds, etfs, why do they charge a fee? And the answer is simple It is to cover the cost of operating the fund, and there's a lot of cost involved here. There's four big ones, and I have them up on the screen right here. So the first one would be the investment management fee. This covers the cost of the investment, research, securities trading and other activities that go into managing the fund. Then there's the trailer fees. These are paid to the investment dealer to cover the day-to-day operations of the fund, again, including research, regulatory compliance, professional management. They have to get paid. The fund manager has to get paid, and if there is no fund manager, then there's all of the computers, the systems for, like an index fund, that manage all of that and the transfer of money going in and out of the fund. There's a cost to that. Then there's the operating cost. This covers accounting, auditing, record keeping, and then there's taxes. The companies have to pay taxes.

12:03

So in this example, if we were to look at the investment management fee let's say it was 0.58% Then we add the trailing fee, which let's say it was 1.1%. Funding costs another 0.12%, taxes, another 0.19%, and that's how we end up with the MER. So in this example, you add it all up, it's 1.99%. And so that's what you, as an investor, is charged every single year, and you get charged that fee. For as long as you own those funds And so you can own them for five years, 10 years, 20, 30, 40, 50 years You will get charged that fee every year. Again, whether or not the stock market makes money or loses money, you still have to pay the fee.

12:53

Now let's take a look at our next topic. What is the actual cost, the true cost of the fees to you. It's more than just looking at the 1% or 2%. There's more to it. So stick around, we're going to go into the details here and we're going to see what is the true cost of those fees to you. Now up on the screen is the same slide I showed in the beginning.

13:17

So typically, a mutual fund has anywhere from 1.5% to 3% annually in fees, index fund 0.5% to 1.5%. ETFs 0.03% to 1%. So what we're going to do in this example is we are going to look at four different fees. So I'm going to start with the highest fee and then we're going to work our way down. So in this example, for the rest of this podcast episode, we're going to take a look at the fee MER annual fee of 2%. Now there are companies that charge 3, 3.5 or 4, but let's stick with 2%, 2%. Then we're going to look at 1%, so a little bit better. Then we're going to look at 0.5%, so better. And then we're going to go even lower, even better, 0.05%. So we're going to look at these four fees and how they would affect you as an investor. Okay, now I know there's funds out there that charge less than 0.05, but I also know that there's funds out there that charge more than 2%. So this is a good cross-sectional sort of subset of fees and that's what we're going to go with.

14:38

Okay, so now, if you look up on the screen here, when you just look at the fee, it doesn't seem very high, right? 1% doesn't seem like a very high fee. 0.05% doesn't seem very high. And if you just look at the first year cost, again not very high. And if you look at the amount invested, right, if you're gonna invest $500 or $1,000, the fees are not too bad. They don't seem too bad.

15:06

So in this example, again, like I said, we're gonna go with the four types of fees 2%, 1%, 1.5% and then 0.05%. Okay, so let's let's assume you invest $5,000. Okay, after one year, if the fee was 2%, you're gonna spend $100 in fees. So again, doesn't seem too bad. If the fee was 1%, you spend $50 in fees. If the fee is half a percent, then you pay $25 in fees. And if the fee is 0.05% and remember you invested $5,000 after one year your fee is $2.50. So that again doesn't seem very high and the number seemed pretty low and pretty reasonable.

15:54

However, what is the actual cost of those fees. So now we're gonna look at the true cost, and the true cost depends on four things. Number one, the amount of money you invest initially. So it's gonna make a big difference whether you invest $500 or you invest $500,000. So that's one. Number two, your continued contributions, which means the amount of money that you invest regularly, every month or every year. And number three, we're gonna look at the rate of return. So the better the stock market returns and the higher the fee is gonna be to you that you have to pay. And then, lastly, we're gonna look at the time how long do you stay invested? so all of these four things combined is gonna give us the true cost of these fees to you and to your portfolio, and what's really coming out of your pocket because you have to pay those fees.

16:56

Okay, so this is the example we're gonna use and we're gonna make some assumptions here. So I'm gonna assume that you are initially investing $500,000. Now this is ever. This includes everything your 401k, your IRA if you're in Canada, it's gonna be your RSP or your RIF or your TFSA, all of your accounts, non-registered accounts, so even accounts that are not for your retirement, but you you have, like a trading account or an investing account. So all of your mutual funds, index funds, etfs we put all that together. So let's say, today and again, based on your age and where you're at and kind of work that you do, let's say you start off with $500,000. That's what you've got invested. Total across all your accounts $500,000.

17:47

Okay, next, we're gonna assume that you invest $500 a month regularly. Some of you will invest less than that, some of you will invest more than that and most people regularly contribute to their 401k, ira, rsp, tfsa, especially if you're an employee. Sometimes you'll have employer matching, so the employer will contribute on your behalf every month or every paycheck. So in this example, i'm gonna assume $500 a month of regular contributions. Next, rate of return. So if you look at the stock market, the last 85 years stock market history, and if you read through a lot of books talking about the historical rate of return for the stock market, it's been anywhere between 10 to 12%. So 10 to 12%. So what I'm gonna use here is I'm gonna use 8.5%. So we're gonna be a little bit more conservative and we're gonna say okay, the average annual rate of return over the long term 10, 15, 20, 30 years is 8.5%. So that's what we're gonna assume here. And then, lastly, i'm gonna look at what your fees are after 25 years and after 45 years. So those are the two time limits. So these are all the four assumptions.

19:17

We're gonna start off with $500,000 initial investment. We're gonna contribute $500 a month, we're gonna assume the rate of return is 8.5%, and then we're gonna look at the time, which is 25 years and 45 years. So let's see what that looks like. You can see up on the screen here, even before I jump into the fee, i'm gonna give you an idea of what your portfolio, your investment, would be worth after 25 years. So take a look at the first line. We have $500,000 invested with an annual fee of 2%. After 25 years, that investment is going to grow to 2.79 million dollars, so not bad. After 45 years, that investment is going to grow to 10.08 million dollars. Okay, not bad. And keep in mind there's the initial investment plus the $500 a month for the next 25 years and 45 years. If we look at the second line on the screen, same $500,000 investment, but now the fee is cut to 1%, so the fee is half. Now, after 25 years, the portfolio is going to be worth almost $3.5 million, and after 45 years it's going to be worth over $15 million.

20:41

Now, if we go down to the third row again, all the assumptions are the same. The fee is 0.5%. Okay, 0.5% fee, your portfolio after 25 years will be worth almost $4 million. After 45 years it'll be worth over $18 million. And the last row is the least amount of MER fee, which is 0.05%, and you can see that after 25 years your portfolio will be worth over $4.3 million And after 45 years it would be worth over $22 million.

21:18

So, looking at the screen, do you notice anything? As the fee is going down, the fee is getting less and less. The value of your portfolio is getting bigger and bigger. Why? Because you're paying less in fees, and when you pay less in fees, the money you save gets reinvested and, because of compounding, your money grows even faster. So you can make more money if you pay less fees. So now we're going to take a look at the fee itself. And what does that look like? Now, for those of you that are interested, at the bottom of the screen there's a URL.

21:58

I want to thank our friends at nerdwalletcom. They have a fantastic mutual fund calculator. You punch in all the numbers and that's what I did for this episode. Here. You put in your initial investment, your MER, your rate of return, the number of years that you're going to hold on to the investments, and the calculator will calculate for you what the fees are. So let's start with the first example. The fee MER is 2%. So 2%, and I'm starting with an initial investment of $500,000. Okay, don't forget the regular contributions of 500 a month. After 25 years you will spend over $1.5 million in fees. Now, that's not a mistake. I'm going to say that again. After 25 years you will have spent over $1.5 million in fees. After 45 years, that's over $12.5 million in fees. Now again, you have the link at the bottom of the screen. I encourage you to go check out the website nerdwalletcom, check out the mutual fund calculator and enter in the numbers yourself, because these are just shocking.

23:19

Now we're going to look at what happens when we cut the fee in half. So let's say we go from 2% to 1%. So a 1% MER fee after 25 years is going to cost you over $867,000 in fees. So I don't know about you, but I could surely use an extra $867,000 in my life. After 45 years, you're looking at over $7.4 million in fees. Now let's reduce the fee a little further and cut it in half again. We're going to bring it down to 0.5%. So a $500,000 investment with an MER of 0.5% after 25 years will cost you over $457,000 in fees. So that is still a lot of money. And after 45 years, you're looking at $4.1 million in fees. Okay, and very lastly, we're going to go to our lowest fee that we were talking about 0.05% Doesn't seem like a big number, but after 25 years, you will spend over $48,000 in fees.

24:33

Again, i don't know about you, but I could use an extra $48,000 in my life. That's the cost of I was going to say, car, but you can probably get a car for cheaper than $48,000. And after 45 years, you're looking at spending over $449,000 in fees. So you can see that the fees add up over time. Right, when it was, when we were only looking at the $5,000 investment after one year, it didn't seem like a lot. But after 25 years, after 45 years, these fees are going to add up and they are going to prevent you from achieving financial success sooner than later. Right, because these are going to take a big chunk out of your investment portfolio.

25:27

Now, because it's automatically deducted once a year, it's easy to miss. A lot of these fees were hidden fees for many, many, many years Now because of legislation I know in Canada they have to disclose in your annual statement what the fee is. But again, it's easy to miss. And when you don't see it, when you don't see the dollar amount next to it, it's easy to miss. But it does add up. Even the smallest fee is going to add up to thousands and thousands of dollars. So if you could save this, if we could reduce the fee to zero, you could save these amounts that you see on the screen here And you can pocket that money for yourself. So that brings us to the last topic in our episode How can you eliminate the fees?

26:18

So how do you avoid paying the fees? How do you get rid of them? And the answer is by investing for yourself, by yourself. So this is a do-it-yourself approach And you would invest directly into stocks yourself, and not just any stock We're going to talk about that in a minute But by investing directly into those stocks, instead of doing it through a mutual fund or an index fund. Just do it yourself, then you eliminate the fee altogether.

26:51

So here's the fees up on the screen again. We just looked at them two slides ago, big numbers. But if you look at the very bottom row, what I'm showing you, there are the cost of buying a stock yourself directly. So now a lot of places have zero commission So they don't even charge now for buying stocks or selling stocks. There's still some places that will charge $5 a trade, for example, on a $500,000 portfolio. If you divide that by 10 and a $5 trade, you're looking at $50. It's $50, not every year, not every month, but a one-time fee $50 when you buy those 10 stocks and then you just hold on to them, that's it. So a $50 cost, even after 25 years, versus a mutual fund that has an MER of 2% where you lose $1.5 million in fees. So look at the difference $1.5 million in fees versus $50 one-time cost.

28:02

Right, all the mutual fund fees. As long as you hold the mutual fund, index fund or ETF, you're going to keep incurring those fees, whereas with individual stocks, if it's zero trade commission, then you're not paying anything. If it's $5 a trade, then you're paying $5 a trade, but one time when you only buy the stocks, and that's it, if you ever decide to sell them again. if it's $5 a trade, it's going to cost you $5. So the cost for holding the stocks yourself is insignificant when you compare it to the cost of the funds.

28:37

So, again, the key here is by investing for yourself, by yourself. And I know what you're thinking Automatically when someone says why don't you invest by yourself? Here's the questions and the thoughts that go into your head. Number one I don't know how to invest, right? you might be thinking that The other question that comes in your mind is I'm not an expert, isn't this risky? The other question is what do I invest in? When do I buy and sell? How do I manage my investments? Right? so those are all very good questions. Same questions I had when I started my journey more than 25 years ago. I've been a dividend investor for over 25 years now and I've talked to many, many, many people who have the exact same questions.

29:30

So the first question was I don't know how to invest. Well, stick around, i'm going to show you that in this episode how to invest. The other one was I'm not an expert, isn't this risky? Well, you don't have to be an expert. You don't need a fancy degree in accounting or finance to do what I do and what I teach. And isn't this risky? Well, it's actually less risk, because when you invest in a mutual fund, that's investing in 500 stocks or thousands of stocks, same thing with an index fund, same thing with an ETF. You are buying so many stocks in there and not all of those are quality stocks. Not all of those stocks pay dividends, not all of those stocks have low debt. So to me that's risky, whereas individually selecting the stocks, you can lower your risk And you don't need to be an expert. And the other question is what do I invest in? Well, stick around, we're going to cover that in this episode. When do I buy and sell? We're going to cover that in this episode. And how do you manage your investments? I'm going to cover that very briefly And so let's jump right into that right now.

30:39

So my approach to investing and what I teach is how you can invest safely and reliably for the long term, regardless of what happens in the stock market, regardless if we have a market downturn, if there's a market crash, we want to invest safely and reliably, consistently, and we want to do it over the long term. So we're not day traders. We don't think in terms of days or weeks, we think in terms of decades. We want to invest for the long term. So my approach is to invest in quality dividend stocks when they're priced low. Okay, so not just any stock has to be a dividend stock. Not just any dividend stock has to be a quality stock, and not just a quality dividend stock. It has to be priced low. Right Stock prices go up and down all the time. We want to buy when a stock is priced low.

31:34

So how do you know, when you're looking at a stock, if it's a quality dividend stock and how do you know when it's undervalued? Well, easy, you follow the 12 rules of simply investing. I have them up on the screen right now. This is your checklist. A stock must pass each of these 12 rules before you invest in it. Okay, not just pass nine out of the 12 or eight out of the 12. Has to pass all of the rules. Has to get a 12 out of 12 before you invest in any stock. So for those of you that are listening to the audio version, i'm going to go through the 12 rules here. Now rule number one do you understand how the company is making money. If you don't skip it. You don't need to be an expert, just have to have a general idea of how they're making money. How does McDonald's make money? How does Walmart make money? That's it, simple questions.

32:25

Rule number two 20 years from now, will people still need its products and services? If not, if you're not 100% sure, skip it, move on to something else. Rule number three does the company have a low cost competitive advantage? Rule number four is it recession proof? Right? If there's a, if there's a market crash or we're in the middle of a recession or there's a chance you may lose your job, are you going to go out and buy a new car Course? not, and for that reason alone we don't invest in car companies.

32:56

Rule number five is it profitable? Rule number six does it grow its dividend? Rule number seven can it afford to pay the dividend? Rule number eight is the debt less than 70%? So if you're looking at a company and the debt is 500% or 200%, it fails. Rule number eight skip it, move on to something else. Rule number nine we want to avoid any company with recent dividend cuts. Rule number 10, does the company buy back its own shares? And rule number 11, is the stock priced low. So we check for three things. We look at the PE ratio. We want to make sure it's low. We want to make sure the PB ratio the price to book ratio is low. And then we want to compare the current dividend yield to the company's 20 year average dividend yield. And if a company passes those three rules in rule number 11, a, b and C, then you know you're looking at a company that is priced low. And rule number 12, keep your emotions out of investing.

33:58

So, for those of you that are interested, i cover all of these rules in my online Simply Investing course. It's a self-paced course, you can take your time and it has 12 modules. So we cover the investing basics. Then I cover the 12 rules in detail. I show you how to apply the 12 rules to any stock anywhere in the world And we do this with plain English, no jargon, simple, easy to understand lessons. I also provide you with a Google sheet so you can put all your numbers in And the Google sheet will then apply the rules for you and show you which companies pass which rule and which companies fail which rule. I show you how to use a Simply Investing platform. I take you step by step on how to place your first stock order, so it's really simple.

34:51

Next, building and tracking your portfolio. Then we cover when to sell, which is just as important to know as it is when to buy. Then we talk about reducing your fees and risk Covered. A lot of that in today's episode, but we go into more detail in that module in the course. Then I'm going to provide you with an action plan on how to get started right away, whether you're a beginner or an intermediate, and then I have a module where I answer your most frequently asked questions.

35:22

Now, for those of you that are interested, i spent two years building a web application, a Simply Investing platform, and in that platform we apply these rules automatically every single day to over 6,000 companies in the US and in Canada.

35:39

So just by logging into the platform, you can see immediately which companies you should consider for investing, which ones are quality stocks that are price low and which ones you should avoid because they fail these rules. So for those of you that are watching or listening, take a note of this coupon code. I'm offering a special discount SAVE10SAVE10. So this coupon code can be used for any product and services on our website. I also do personal assessments so we can get on a one hour Zoom call together and we can go through in detail. So you can apply the coupon code there, you can apply it to the course, you can apply it to the platform. So if you enjoyed today's episode, be sure to hit the subscribe button. We have new episodes out every week. Be sure to hit the like button as well And for more information, take a look at our website, simplyinvestingcom. Thanks for watching.

Episode 37: The Key to Predicting Future Profitability & Dividend Growth

Episode 39: (Part 1) How Do You Know If The Dividend Is Safe?