Getting people to care about the investing fees they pay has been one of the most successful achievements in the personal finance field.
But there is still work to do. Too much money sits today in high-fee investing products that do not justify the cost. The consulting firm Mercer Canada has come up with a fresh take on how to pry some of this money loose and then direct it into more cost-efficient options.
Mercer says in its latest Retirement Readiness Barometer that paying typical investing fees can result in having to work years longer to achieve a financially secure retirement, and increase the risk of running out of money after you exit the work force. If that doesn’t get people to review the fees on their retirement investments, nothing will.
The aim of the report is to encourage the adoption of defined-contribution pension plans in the workplace – Mercer is a player in helping companies manage these plans. Less burdensome for employers than defined-benefit pensions and their promise to retirees of cash for life, DC plans still offer some huge advantages in retirement saving. One is that employers typically match worker contributions, while another is that the investment funds used in DC plans are comparatively cheap for investors.
But there’s a broader message from the report for all retirement savers, whether they have pensions at work or not. “I think you can kind of draw your own conclusion that fees matter, no matter what,” said Jillian Kennedy, a partner in Mercer’s wealth business who is responsible for the DC pension business and financial wellness.
Mercer used a cost of 0.6 per cent for the investment funds available in DC plans – that’s the median fee level in Canada for this type of retirement savings vehicle. In contrast, the median fee for balanced mutual funds and other retail investment products comes in at 1.9 per cent.
Comparing the effect of these fees on retirement was done using the example of someone who starts contributions of 6 per cent of gross pay to a DC pension plan at age 25, with an additional 6 per cent from the employer. The money goes into a target date fund, which is a balanced portfolio that automatically gets more conservative as you age. Annual returns were estimated at about 6.2 per cent before fees pre-retirement and 4.9 per cent afterward.
In this example, the employee’s goal is to have 70 per cent of their working income when retired based on pension benefits plus the Canada Pension Plan and Old Age Security. Employment income is assumed to be roughly $100,000 in today’s dollars prior to retirement.
To reach this level of savings, someone paying fees of 1.9 per cent instead of 0.6 per cent would have to work four extra years. The study goes on to show how much longer your money lasts in retirement when you pay a low fee. Investing at 0.6 per cent both pre- and post-retirement would give you an average 12 years of additional income over someone who paid 1.9 per cent both while working and after retirement. Retirement at age 65 is assumed here.
One of the ways we can tell that people are more fee-conscious is the steady rise in popularity of exchange-traded funds, which are an ultra-cheap way to invest for retirement and other goals. Particularly important are asset-allocation ETFs, a fully diversified portfolio of stocks and bonds packaged in a single cheap-to-own fund.
The cost of owning asset-allocation ETFs as measured by the management expense ratio starts at 0.2 per cent. There may be additional cost in the form of stock-trading commissions to buy and sell these products, but there are a growing number of commission-free brokers to choose from.
Why participate in a DC plan if do-it-yourself investing saves so much? Matching employer contributions are one great reason, while another is that your contributions are deducted right off your paycheque and thus not susceptible to your own subjective feelings about whether it’s an ideal time to save for retirement.
Part of the process of making investors more aware of costs has been to criticize mutual fund fees in a not entirely fair way that omits mention of something we’ll call the advice factor. The MERs for mutual funds include fees to cover the cost of service from an investment adviser. There are a bunch of ways an adviser could add value that justifies the higher fee, like coaching you to save more, spend less and to stay invested in a well-diversified portfolio rather than chasing trends.
But advisers who are primarily product sellers collect their fees while giving little or nothing back. The Mercer report shows how this extra cost can delay your retirement and increase your risk of running out of money.
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