Are You Paying Too Much For Your Investments? Probably.

Plenty of regular people are sceptical about paying a company to manage their money, and for good reason. But the reason may not be what most people suspect. People often talk of the stock market being like a corporate casino. You buy stocks. The people who sold them make money. You lose money. Finally you cash in your stocks and shake your head without even the benefit of a complementary dinner or live show.

But this sad picture isn't quite right; the stock market--and by extension, the mutual fund market--has been a clear win-win proposition for decades. Probably centuries. It's just that the investment manager wins more than the typical investor. In Canada, investors who buy stock mutual funds pay an average of 2.56% of total money invested to the manager of their fund, which is about 42% of the historical return (6.1%) of the Canadian stock market per year. In other words, if you invest $100,000 in your pension fund and the market returns 6.1%, you pay out $2560 every year to have it managed. That would leave you with $3540 in investment returns*.

Investment managers claim that they are justified in charging such high rates, since they can pick the best stocks and beat the market. Researchers (at Morningstar, for one recent example) have been quite critical of this position for some time, and it looks like the fund managers are finally starting to learn.  Jason Zweig at the Wall Street Journal reports that fund managers seem to be giving up on the proposition that they can beat the market at all (See also here. But ignore the absurd headline.) Instead, these savvy managers are buying passive index funds which are simply a large group of stocks that move in line with the stock market as a whole. Now if even your money manager has given up on the idea that they can beat the market, why should you pay them 2.56% of your investments?

There is really no reason that I can conceive. You would save yourself a lot of money by instead buying a Vanguard Canadian stock index fund for a fee of 0.05% of your investment. At approximately 50x cheaper than the average mutual fund, you can save about $2500 per year in investment costs if you invest $100,000. Or you could buy an American stock index fund for 0.15%. If you don't like Vanguard as a company for some reason, i-shares sells a similar American index fund for 0.11% of your investment. There are a host of stock market index funds and bond funds sold all over the world that have much more reasonable fees than what the typical Canadian has been sold on paying.

Of course, investing is risky business and stock index funds are not guaranteed to outperform all mutual funds. But the traditional mutual fund is at a distinct disadvantage relative to passively managed index funds. And if you happen to have money already set aside in a traditional high-cost mutual-fund, there may be tax implications of transferring that to an index fund, so don't go cashing out everything without doing your homework. Financial advisors (not me) can be quite useful in sorting through the legal details in that regard.

So good luck out there, in these turbulent times. I hope we investors can save a bit more on unnecessary fees and get a few more bucks in our pockets. Maybe we'll even run into each other at the poker tables some time. Be kind.



*Fear not, perceptive reader. Your Sceptical Economist realizes that the managers' calculated fees of $2560 are not more than your expected returns of $3540. If stock returns were exactly 6.1% every year, you, the investor would indeed get about $1000 more than the manager. But a variety of factors make this a better shake for the manager, including investor decision errors, and the compounding effects of variable return rates. 

*Photo source: http://www.freeimages.com/photo/money-down-the-drain-1537821