RRSP season puts spotlight on low-cost investing
In an era of low returns, investors are flocking to options that charge fewer fees
Canadians had lots to consider as they made their final RRSP decisions for the 2016 tax year. In particular, in an era of low returns and low interest rates, one challenge is to find low-cost investment options.
Despite strong returns on the Toronto Stock Exchange over the past year, the index just recently made its way back to levels last seen in 2014. And persistent low interest rates have made returns for fixed income investors even worse.
New rules implemented this year make it clearer just how much Canadians pay for their investments and the advisers who manage them. That's led many investors to seek out lower-cost options.
Buffett and 'the lucky monkey'
Even one of the richest people in the world says money managers aren't worth the commissions they charge. Last weekend, billionaire Warren Buffett wrote in his latest letter to shareholders of his Berkshire Hathaway holding company that many would be better off buying cheap index funds than trying to beat the market.
"If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet," Buffett wrote.
"But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."
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Rico Dilello stepped out of that line for good more than a decade ago. The former financial adviser sold mostly mutual funds, investments he said didn't pay off well for his clients.
Former adviser frustrated by fees
"I felt bad that I'd be making money and my client would be losing money," said Dilello.
That's because advisers like Dilello often earn fees for selling mutual funds regardless of whether the investments themselves do well or poorly.
Investors of funds that fail to beat or even match the market aren't so lucky.
Most mutual funds are a basket of stocks, often managed by a professional whose goal is to buy winning stocks and drop losers — actively buying and selling in an attempt to beat the market.
Buffett has given investors a 1.9 million per cent return over the last half-century doing exactly that — betting on undervalued companies and reaping the gains as their stock prices rise. But even he says most investors trying to do that today via actively managed mutual funds are playing a fool's game.
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He recommends low-cost index funds — funds that track the performance of an entire index of stocks, rather than picking and choosing winners and losers.
Those funds may not "beat" the market, but over the long haul matching it can be more than enough — as long as they aren't paying high fees to managers who underperform.
It may not sound like much, but even a two per cent fee can add up to a lot over time.
Consider this: if $10,000 is invested with an average rate of return of five per cent, after 20 years that investment would grow to $26,533. But, a two per cent fee on that investment would significantly eat into those gains. After 20 years, that $10,000 would have grown to just $18,061. Meaning fees charged would almost equal the initial investment — $8,472.
'Conscience' inspires adviser to quit
Dilello said he especially struggled with selling mutual funds to his friends and family.
"You don't want your family or friends losing money, right? And so when you start doing that, you have a conscience. And I just said, 'You know what, I can't do this, I just can't do this anymore.'"
Dilello quit. Now retired, he takes Warren Buffett's advice with his own money: it's mainly in low-cost index funds and exchange-traded funds, or ETFs.
ETFs are similar to mutual funds: they can also be a basket of stocks, but you don't need a financial adviser to do the buying and selling for you. They trade like stocks and for the most part they're also much more passive — most don't buy and sell stocks repeatedly, like some funds do.
That keeps trading costs low, which leaves more returns for the original investor — not the fund manager or salesperson.
Popularity of low-cost ETFs growing
They're still relatively new, which explains why ETFs make up just eight per cent of all funds invested in Canada. But they're growing.
According to the Canadian ETF Association, at the end of last year there was $113.6 billion worth of assets sitting in Canadian ETFs. That's up by almost 27 per cent from a year earlier. Mutual funds, meanwhile, saw their assets grow by just 7.7 per cent over the same period.
On the whole, ETFs are also much more driven by technology such as algorithms or other asset screeners, which make them much more accessible and cheaper for investors over the long haul.
Using technology to reduce fees
One Vancouver-based online investment firm — or robo-adviser — is combining its own technology with a strong focus on ETFs to reduce fees it charges clients.
WealthBar says it holds about half of the assets it manages in ETFs.
"The ETFs market is growing so rapidly," said co-founder Chris Nicola. "This is allowing Canadians to access broad diversification at a lower cost now."
Even though WealthBar relies heavily on technology — it uses algorithms to choose the right portfolio for clients based on how much risk they're comfortable with — it still promotes paying for professional financial planning advice.
"A lot of people need to go beyond just being able to buy and sell investments," Nicola said. "Having some financial advice and having some guidance makes a big difference because knowing how much to save and having a plan for how to save is going to get you a lot further."