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Get out of the trap: find out how much your investments are costing you

April 11, 2014 by Editor, InvestingForMe

If you’re like most Canadians, over 2/3rds of us have 50% (or just over $1.0 trillion) of our hard-earned savings invested in mutual funds. But did you know that mutual funds are one of the most expensive forms of investment available?

 

And as we outlined in our previous article, a latest study by the independent investment standards research company DALBAR points to 3 main reasons why many of us are such chronic underachievers when it comes to our investment performance:

  1. bad investor behaviour
  2. high investment costs, and
  3. high investment Portfolio Turnover Ratios (PTRs)

So this week we’re going to look at that #2 reason why we’re all underachieving – the high cost of our investments.

Doing the math over the long haul – it hurts!

And according to another recent investment article, Canadians have paid investment costs (such as service and management fees) that have averaged 2.5% for the past 25 years. Now, I know that 2.5% doesn’t sound like a lot, and on $10,000 of savings you might tell yourself that’s only $250.00. But that $250.00 is actually very, very expensive when you compare it with a number of other investment options like exchange-traded funds (ETFs) that cost 1/5th (or $50.00) of that amount!

And if buying and holding mutual funds – the most expensive investment available – isn’t bad enough, the worst part is that that expense gets worse, the longer you hold it.

Example: Let’s expand on our simple $10,000 example above to illustrate how all that wasted money adds up to you losing big time over the long term. Let’s say your expensive mutual fund has an average rate of return equal to 6.0% per year (before fees) for the past 25 years. A simple calculation shows that your $10,000 investment will have grown to $23,632. Not bad, right?

But what if instead you had invested your $10,000 in a lower cost (0.5% per year) ETF that generated the same 6.0% rate of return? What would your $10,000 be worth after 25 years? Answer: $38,133! Now, that’s a whopping $14,501 difference! And that’s a lot more serious money in your retirement pocket!

So, taking the time to study all your options and get out of the usual mutual fund trap will definitely save you big money in the long run.

Increase the value of your savings by 140% – guaranteed! (But ignored!)

Normally it would be outrageous, and maybe even illegal, for anyone to tell you that you can earn a 140% rate of return from your savings, but as our simple example just demonstrated, you can do it. By simply shifting away from high-cost investment options into lower-cost options, you can increase the value of your savings by 140%.

But let’s face it. None of this is new. Over the years, most of us have read dozens of studies and articles that espouse the financial benefits of selling our high-cost mutual funds and buying low-cost ETF alternatives, and yet over the years Canadians continue to ignore this simple logic and continue to sink more and more of their hard-earned savings into mutual funds. Why?

The answer is simple: investing today is big business. And it’s in the best interest of the investment business professionals that you keep on buying those expensive investments that cost you 2.5% each year and not the ones that only charge you 0.5%. Those guys want to keep their jobs and making more money off you with those more expensive mutual funds and their corresponding costly investment fees! They really don’t want you to wake up and do the math.

Time to focus on investments that are in your best interests

So how can you use DALBAR’s recent study to improve your investment performance? Make good investment decisions. Choose investments that make you more money. Remember that generating an extra 140% in returns is within your power – no one else’s. Making that extra 140% is up to you. Your financial advisor is not going to do it for you! And the professional money managers your advisor hires are not going to do it for you! It’s all up to you.

So, the next time you sit down to review your investments, think about these cost-saving must-do’s:

  • Include a review of your investment costs as a part of your analysis. Take the time to calculate what each of your investments cost you each year. Then search for and make a comparison of lower-cost investment alternatives, such as low-cost mutual funds or ETFs.
  • If reviewing the investment costs for each and every investment all at once seems overwhelming, then start small: start by reviewing and analyzing one or two now, and then one or two more the next time. Small improvements are better than no improvements.

Remember: Making investment costs part of your regular investment review is helpful for every investor. Understanding investment costs will help you to improve your investment decisions and your investment performance so that you’ll no longer be one of those investing chronic underachievers.

Next time we’ll wrap up this series with a discussion of how to use DALBAR’s #3 cause of chronic investment underperformance – high portfolio turnover – to again help improve your overall investment performance.

 

Read the next article in this series - Trade a lot? Maybe you (and the Pros you hire) shouldn't!

 

Read the first article in the series - The average investor: chronic underachiever

 

 

(Published by TroyMedia)

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