I’ve been thinking a lot about fees lately. Namely, the fees on my mutual funds.
If you’ve seen any of my monthly snapshots, you’ve probably seen that I have more than one retirement savings account. There are two accounts that have money actively moving in; one through work, and one at a bank.
The one through work is with a company that sells a variety of mutual fund products. Their MERs (management expense ratios) range from between 2.5% to 3.5%. If you’re not familiar with MERs, it’s the percentage of your account balance that goes to the financial institution each year to pay for the care of your account. These MERs are high, but not out of whack compared to what a lot of Canadians are paying in fees on their accounts. The saving grace to the high fees is that I have employer contributions and matching as well. They put in 3% automatically, and match 50% of the next 3% that I put in as well. Basically for the first 3% I get a 150% employer contribution match.
The account at the bank has much lower fees; the fees on this account are closer to 0.5%. I don’t get anything in terms of investing assistance or advice, but it’s a much more inexpensive place to stash my money.
I’ve been wondering for the last little while whether it was better to direct my contributions into the high cost account with the free money, or if I should put it all in a low cost account, where the only money that goes in is what I contribute?
Sounds like a job for graphs!
I plotted a $100 contribution with an MER of 0.5 against six $100 contributions with contribution matching and an MER of 3.0. I did this for four different rates of return (4%, 6%, 8%, 10%) to see how much of an impact it would have on the results over the course of 40 years.
Lump Sum - 4% Rate of Return
Lump Sum - 6% Rate of Return
Lump Sum - 8% Rate of Return
Lump Sum - 10% Rate of Return
I was shocked to see that the low cost fund beat out all of the higher cost funds with contribution matching over a 40 year period. It started overtaking the contribution matched funds after the first 10 years in all four cases.
After plotting the different scenarios it occurred to me that my graphs weren’t entirely accurate. Sure, it’ll be close to 40 years before I retire, but do I plan on contributing once and just trusting that it’ll be enough at the end? I don’t think so. I plan on contributing throughout my working career. How does that affect it?
I adjusted my chart to include consistent contributions every year. The results are a little less clear cut than they were before:
Annual Contributions - 4% Rate of Return
Annual Contributions - 6% Rate of Return
Annual Contributions - 8% Rate of Return
Annual Contributions - 10% Rate of Return
They’re a little harder to read, but again the low fee funds start beating out other funds in less than 20 years. The rate of return had a larger impact here. At a 4% rate of return the low cost fund matches the fund with a 75% contribution match after 40 years. At a 10% rate of return, the low cost fund matches the fund with a 100% contribution match after 40 years.
That’s absolutely incredible when you think about it. You’d have to start with, and steadily contribute, twice as much money in one fund as you would in the other just to pay for the fees. You do this just to end up with the same amount of money at the end of the day. All that free money has amounted to nothing.
It just goes to show that fees matter when it comes to investing, and that not all easy answers are as easy as they look. If you were offered a 50% contribution match at work, would you take it? Would you have looked at how the fees on the account would affect your money over time? I hadn’t before now, and I’m a little perturbed by the results.
If you have fewer years to retirement, and have a great contribution matching program, it’s a no brainer. If you’re younger, however, and if your contribution matching is on the smaller side, you may be better off saying no to the free money and investing it yourself in a less expensive fund.
Crazy, I know.
I’d have to be getting a consistently incredible rate of return over the next 40 years to make turning down the 150% contribution match worth while. That being said, anything I put in on top of what I’m currently putting in there won’t be matched at the same rate. It’s worth it for me to keep my current contribution rate going at the office, but anything on top of that is better off going into my low fee account. I’m happy about this, because it’s what I had planned to do anyway.
What fees do you currently pay on your retirement accounts? Have you ever turned down free money? Would you?
Recommended Reading: Sh*t my boss says/This is why personal finance is important to me.
