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.
2.5% – 3.5% are criminal expense ratios. You are getting robbed.
Let’s look at it this way. What is the yearly return you expect on your investments over the next forty years?
If we include dividends:
Last 5 years: 2.3%
Last 10 years: 4.5%
Last 20 years: 9.4%
If we exclude dividends, then subtract around 2.8% off each figure.
If you guess 8% return, then 10 years from now, the DJIA will be at 27900. Do you see that happening? Do you even see DJIA 20000 10 years from now?
Anyhow, take whatever figure you think is realistic, then immediately subtract 3% off that. Yeah the ER you are paying effectively cuts your yearly returns by that amount.
3% is a TON TON TON, esp over the long run. If you were to invest $17,000 / year (401k contribution limit) for 40 years. And you expected an 8% return -> $7,372,933. But then if we take the 3% ER into account, you would effectively be getting a 5% return rate -> $2,897,704. 3% doesn’t sound like much until you start compounding it over a period of many years.
It sucks that we don’t have control over the ERs of our retirement accounts. I complained heavily about it where I work and got us to switch to a different company. From ~3% ERs to around 1.5% ERs.
For brokerage accounts that you control, I recommend Vanguard ETFs which are in the 0.10% – 0.20% ER range.
Oh trust me, I know we are. Canadian mutual fund fees are on average about twice what the American fees are. I’ve worked for a few companies, and so far all of the group mutual funds that have been offered have been equally expensive.
I suppose I should have clarified, the graphs I put together already have the MER taken off. For example the 8% graphs have the outside RRSP growing at 7.5%, and the matched ones growing at 5%.
I did notice that Vanguard started selling its ETFs in Canada recently. I had to look them up again when you mentioned it. It looks like the 6 on offer charge between 0.09% and 0.49% That’s pretty good! I’ll have to see what other fees they charge upfront, because I seem to recall it being written on more than one occasion that ETFs weren’t a good option for investors who were just starting out and didn’t have a lot of money to invest yet. Hopefully they’re low so I can get started sooner rather than later.
bahahaha I just laughed so loud (in the awkward, all alone way in a crowded office) when I got to “sounds like a job for graphs!”
Crazy what fees can do! You know their bad but your charts really prove how much =\
Lol, I’m glad you liked that
Yeah, I was kind of disgusted by the one where I was only breaking even with the 100% contribution match. Any company that says they’re having a hard time making ends meet after charging those fees is either completely full of it, or deserves to go under!
I’m quasi lucky that we actually get a broader range of choices for mutual funds that the company matches. Even though the typical funds are pushed/highly recommended by the mutual fund, there are cheaper options of funds that we can invest it.
Most of my funds are between 0.5% to 1%, so I don’t buy into their scheme of having funds with very high MER. However, I am going to decrease my contribution to my company mutual funds as the ones at TD e-series are even lower!
And I love the graphs! It makes everything so clear.
That’s awesome that you have options! I looked through mine, the low fee options were pretty slim.
I’m glad the graphs helped
I was worried they might confuse people.
I’m not gonna lie … reading through this post was like reading in a foreign language to me *blush* and made me SO glad I have a financial advisor lol. I do have an RRSP – which basically is just a savings account since I’m afraid to be agressive and lose $$$. I’ve got a post on free money coming up too
Is your financial advisor fee based, or commission based? Would you like to learn more about it?
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I try to avoid fees with everything but until this post, I never knew they could be so detrimental. For a low fee/no fee option to beat them out in the long haul is amazing.
I’ve only got one retirement account at the moment, the company plan is set to start this year but I don’t think I will be remaining there long enough. Anyways, my retirement account is an RRSP through my credit union. I think I got a pretty sweet deal with it because it carries no fees and has a guaranteed minimum return rate of 5%. It doesn’t have options of what to invest in and I like it that way because it’s less stuff to worry about and no worries about losses. I want my next retirement account to have options though.
I’m curious, how do they guarantee a 5% return? Usually I get alarm bells going off when I read that. Are their interest rates still high?
Am, well it’s my credit union for starters, and you have to remember that my local currency is about half of yours so my interest rates are usually double what yours currently stand at.
The regular interest rates on accounts is about 2.5% at all the banks over here. I think that my calm down your alarm bells a bit.
Very much so, I wasn’t up on rates in your neck of the woods. Thanks for the lesson