cost of investing, The

Shareowner, Mar/Apr 2003 by Sandra Foster

On the train to London the other day, the person next to me said, "I didn't mind paying 2.5% when I was earning 14%, but now that market conditions have changed, I'm paying closer attention to my costs." And he's not alone.

The less you pay for your investments, the faster your money can grow - all other things being equal. Namely, that you can compare investments which are similar in every way (e.g. gross rate of return, tax effectiveness, etc.) except for their costs.

This statement is not to suggest that returns don't matter. Of course they do.

If you consider comparable portfolios, it is still better to own the one that costs 2% a year and earned 10% before fees instead of the one that cost 1% a year but only grew 3%.

How Much Does My Portflio Really Cost?

The investment business is big business. Warren Buffet, considered to be one of the greatest modern investors, has estimated that American investors pay more than $100 billion a year for financial help.

A Simple Rule Of Thumb

When managing investments: the more people who handle your money; the more you see your investments advertised; and, the more real or perceived services your money receives; the more you are likely to pay.

Consider breakfast cereal. The raw product, whether it is oats, rice or another grain, costs just pennies to grow. But the cost increases when the cereal is heavily sugared, packaged and advertised. And that breakfast cereal costs even more if you order it in a hotel restaurant.

Similarly, it costs less to buy a stock market index than an equity mutual fund. The average actively managed Canadian equity fund has no up-front charge but does deduct about 2.30% a year for management and other expenses. However, mutual fund costs are generally less than the cost of investments inside a universal life policy.

Some Examples. Suppose you pay an all-inclusive fee of 2% annually to have your money managed.

If your initial investment had been $100,000 and was able to earn 10% before fees, after 20 years your account would have grown to $449,133. You'd also have paid approximately $98,473 in fees (about what you'd originally invested).

The above table estimates the value of a $100,000 account and the fees paid over time. It doesn't matter if you're investing in mutual funds, segregated funds, universal life insurance or managed-money investment products, the fees add up over the years.

Low-Cost Alternatives

Today's investment menu includes new, lower cost investments, such as exchange-traded funds (ETFs), like the i60s (S&P/TSE 60 Index), i500R (an RSP eligible ETF based on the S&P 500 Index) and dozens more. These securities trade like a stock and have very low MERs that can reduce the overall cost of an investor's portfolio.

However, some of these new investments do not include all of the features that are found in many mutual and segregated funds, such as automatic dividend reinvestment and SWIPs (systematic withdrawal programs).

[Editor's Note: Free dividend reinvestment and other services are available on the family of ETFs that can be purchased through the Low Cost Investing Program reported on page 91.

In short, investors who don't need lots of features on their investments and who don't believe active money management adds value now have new low cost alternatives to choose from.

SANDRA FOSTER, CFP, RFP, FCSI, TEP, IS PRESIDENT OF HEADSPRING CONSULTING INC.