Don’t be Too Afraid of Fees

Last week I wrote about the taxation of investments and how they relate to generating the maximum net return. I stated that investors often focus on the wrong details when selecting investments and my goal this week is to explain the second half of my idea.

Investors are becoming increasingly fee conscious and while I agree that this is important, the fear of fees is causing many to earn far less in returns than they should. I would like to first state that discussing fees is not only very important but a requirement to entering into any investment plan. At the same time, you need to make sure that you don’t base your investment decisions solely on the lowest fee options.

A couple of years ago, we saw a massive campaign for Exchange Traded Funds (ETFs) as they were touted as being “just as good of an investment” with lower fees. Many Canadians flocked to this investment option and we saw a large amount of money flow into them. Fast forward to the past 6 months and many investors are starting to realize what they’ve lost and the flows are now moving back out of these ETF options. In a quest for the lowest fees possible, many investors lost sight of what was most important – attaining real value for the fees that they paid and earning the best net return.

If you were to compare two Canadian equity funds and one earned an (after fees) 10 year average return of 11.84% while the other earned an average of 7.66% (and that both were of a similar “risk” rating), which would you prefer to own? Now what if I told you that the first fund had actually earned 14.11% per year but had a 2.27% management fee and the second option had earned 7.84% but only had a 0.18% management fee? Any sane person would gladly take the fund with the larger fee since they are still earning a net return of over 4% more each year. Sadly though, the blanket fear of fees has driven many investors to select the second fund (which is an ETF) due to its 0.18% management fee.

To look at the above example a different way, and to further help my point sink in, I want to put this into monetary values. If you had invested $100K in the actively managed fund shown above with the 2.27% annual fee 10 years ago, you would have $300,062 today. If you had invested in the ETF fund shown above, you would have only $209,191 today.

Just in case you think I’m “cherry picking” to provide an extreme example, I want to point out that the ETF I used in this example is one of the largest in Canada with $12.5 billion in assets. The actively managed fund that I used for this example is a core holding from one of the world’s largest investment companies and has been running in Canada since 1988 with a current size of almost $4 billion in assets.

The problem facing most Canadian investors is trying to decide which actively managed investments are actually worth it. The vast majority of the 15,000+ investment funds in Canada are little more than “closet indexers” and provide no real value for the higher fees that they charge. A qualified investment advisor should be able to explain why a fund selected is not like the masses and how the fund manager provides true value for the fees that they charge.

The cost of an investment should always be a consideration but it should never form the centre of your decision. Make sure that the investment managers you choose provide value for the fees that they charge but don’t be afraid of paying some fees in exchange for greater returns.