In last week’s column about the “tyranny” of investing costs, I showed how an annual fee of just 2 per cent can devour nearly two-thirds of an investor’s return over a 50-year period.
In response, a reader sent me this e-mail: “The challenge – if you wish to accept it – is to provide some advice to small and medium investors on how to craft a portfolio that benefits from a reduction of, if not an elimination of, management fees.”
Challenge accepted. Today we’ll look at a few simple ways to keep costs down. There’s no law that says you have to use these methods exclusively; in my portfolio I have a variety of securities – primarily stocks, plus a handful of exchange-traded funds, an index mutual fund and, for the fixed-income component, a GIC ladder.
My costs are quite low – less than 0.1 per cent annually. This includes management fees for the funds, and commissions of $10 a pop when I buy (or, less frequently, sell) a stock or ETF. As a buy-and-hold dividend investor – and a committed cheapskate – I do very little trading. Here’s a rundown of some low-cost investing options for do-it-yourselfers.
Low MER active funds
Not all actively managed mutual funds have supersized fees. Fund companies such as Mawer, Steadyhand and PH&N typically keep management expense ratios between 1 and 2 per cent (or lower). There are even a few bargain funds at the banks: One example is the RBC Monthly Income Fund, with an MER of 1.2 per cent (or 0.87 for RBC Direct clients). Unfortunately, the fund isn’t eligible for registered accounts. One advantage of mutual funds is you can contribute small amounts monthly, and reinvest all your distributions without commissions, giving you the full benefits of compounding.
Passive index mutual funds
You can slash your costs even further with index mutual funds. As with active funds, there are no commissions for making regular contributions or reinvesting distributions. But because index funds track a benchmark and don’t have to pay a manager to pick securities, the MERs are lower: typically between 0.6 and 1 per cent. TD’s e-series index funds are cheaper still, with MERs as low as 0.33 per cent, but they’re available only to TD Waterhouse and TD Canada Trust online clients.
ETFs come in more flavours than you can find at Baskin-Robbins: There are passive ETFs, active ETFs, currency-hedged ETFs, leveraged bearish ETFs, covered-call ETFs. My advice: Choose the simplest with the lowest cost and the broadest exposure to the market or sector you want. Companies such as BMO, iShares, Horizons and Vanguard sell broad Canadian and U.S. index ETFs with MERs of less than 0.2 per cent. What’s more, a number of brokers – including Scotia iTrade, Virtual Brokers, QTrade and Questrade – offer commission-free ETF trades, with certain restrictions. Most brokers let you reinvest distributions, but usually in whole shares only, and some allow preauthorized contributions at no charge. Rules vary depending on the broker and ETF provider.
This is the cheapest option, but it also requires the most homework and monitoring. The beauty of owning stocks is that, once you pay your $10 commission (or a bit more or less, depending on the broker and your account size), no money silently leaves your account in the form of fees – it’s all working for you. True, you’ll usually have to pay a commission if you buy more shares or sell existing ones, but you can manage these costs by choosing stocks you intend to hold for many years. Dividend reinvestment plans – whether a “virtual” DRIP through a broker or “true” DRIP with the company’s transfer agent – can also reduce costs and make the most of compounding.
Keeping your costs down is about more than choosing low-fee products; it also requires a mindset that stresses long-term investing over trading. Taxes also matter: You can keep more of your money working for you by maximizing registered retirement savings plans, tax-free savings accounts and registered education savings plans. Finally, if you keep costs down in other aspects of your life – not just in your portfolio – you’ll have more money to invest in the first place.