Today I’m going to aggravate even more individuals than I typically do, because frankly I have a lot of family and friends who make their living selling mutual funds. By the afternoon I’m willing to bet that I’ll have a dozen negative emails with adverse reactions, snarky comments and excuses identifying why the items I’ve outlined in this article are invalid and why my approach is “too risky”. A warning in advance to financial advisors, I won’t respond to your comments, they are biased and I know my article is risking your cashflow for the benefit of your coveted customers. It’s unfortunate that average investors will be persuaded to listen to such rhetoric because well, simply put – it’s complete bullshit!
Okay so here’s a picture-perfect scenario. This is you. You buy mutual funds. You have for years. You are very happy with the returns. As you can see, even though it’s unlikely, I’ve chosen the best case scenario for the sake of this explanation because there are a hell of a lot of naysayers out there (usually financial advisors in this instance because I’m cutting their commissions out of the equation). Now; let’s assume that you’ve chosen a high quality mutual fund that is managed perfectly, with low fees, consistently high returns and is executed entirely ethically – nobody is generating a single dollar of additional revenue beyond the managed fund’s fee of 2.9%. Sounds like a dream come true, right?
Unfortunately, even if this is the case… it’s still not your best choice. And why is that?
Simple! In order to maximize your returns, you need to leverage the power of compounding. Depending upon your average annual return, it’ll require a different number of years to double your returns. Look at this chart:
| 5% | 14.4 years |
| 6% | 12 years |
| 7% | 10.3 years |
| 8% | 9 years |
| 9% | 8 years |
| 10% | 7.2 years |
If your investments earn you an average annual return of 8%, your investments will double every 9 years; however if your investment only earns you an average annual return of 5% it’ll take a whopping 14.4 years to double your initial investment. All while your colleagues who are earning 8% have almost doubled their investment yet again. Using $100 as an example, at 8% return within 10 years you would have $215.89 however with only 5% return you would have $162.00; doesn’t seem like much right? But once you compare this example using more realistic numbers and timeframes it does… behold what $100,000 looks like invested with and without fees…
| # of Years | Bob: 7.5% annual return | Jennifer: 5.1% annual return |
| 5 | $143,562.93 | $128,237.07 |
| 10 | $206,103.16 | $164,447.46 |
| 15 | $295,887.74 | $210,882.60 |
| 20 | $424,785.11 | $270,429.66 |
| 25 | $609,833.96 | $346,791.07 |
| 30 | $875,495.52 | $444,714.69 |
When you look at Bob in the above example, who invested in index funds and received an average return of 8% over the course of 30 years (less his 0.5% fees) and compare him to Jennifer whose managed mutual fund also received the same average stock market return of 8% (less her 2.9% fees) you’ll be able to notice the impact that those fees… Bob and Jennifer invested the same amount and both received average market returns, but Jennifer had higher fees to pay than Bob. The result? Bob’s got a whopping $430,780.83 additional to enjoy in retirement. Not bad for a minor shift in strategy. Still too much work for you to consider changing? Are you willing to literally throw a massive house in the garbage? When you think of it in terms of what you’re leaving on the table, it’s a real eye-opener!
What’s this got to do with a managed mutual fund? The reality is that regardless of the performance of the mutual fund, you will be charged managing fees and these are typically 2.9% (or sometimes higher!). “But, these managed funds will perform better and therefore will have higher returns!” you say. Let’s look a little deeper…
The average stock market return is exactly what it sounds like – an average of all investments returns for the last year. 50% of investments will beat this average, and 50% of investments will do worse than this average. The odds of your mutual fund managing team consistently beating the average are practically non-existent! Even one of Canada’s major banks best managed mutual fund (whom will remain unmentioned based upon their request) that had 8 years of consecutive market-beating performance lost almost all of those gains in the last 3 years!
More importantly, even if your mutual fund beats the average consistently year over year by an average of 2% you’re still thrown away 0.9% per year because you’re paying that fee regardless of how good or poor their performance was. Worse yet, for those horrible years when your investments lose money, you’re out the total loss plus you still pay their 2.9% fee!
But what is the alternative? Is there one? Yes! It’s called unmanaged index funds. In Canada, the Toronto Dominion Bank offers e-Series index funds with low expense ratios; in the US you will be looking at Vanguard.
| Canada (TD e-Series) | Annual Expense | United States (Vanguard) | Annual Expense |
| International Stock Index (TDB911) |
0.50% | Vanguard U.S. Bond Index (VBMFX) |
0.1% |
| Canadian Stock Index (TDB900) |
0.31% | Vanguard Total U.S. Index (VTSMX) |
0.06% |
| U.S. Stock Index (TBD902) |
0.33% | Vanguard Total International Index (VGTSX) |
0.18% |
| Canadian Bond Market Index (TBD909) |
0.48% |
What are index funds? An index fund invests in all the stocks that are within a specific market (e.g. if you put $100 a month in a stock market index fund, you’ve invested in all the stocks; if you put $100 in a bond market index fund you’ve invested in all the bonds). Because index funds aren’t managed, there’s no buy/sell/buy/sell cycles they don’t have ridiculous additional management fees that bite into your profits. But, won’t you get the average return of the entire stock market? Yes! That’s precisely the goal and it’s called the couch potato approach to investing advocated by many of the richest people in the world (remember when I mentioned that you should follow the advice of those you want to become?)… on top of that by getting the average returns you’ll be beating 49.99% of all investors; after all it is the average.
There are additional important tips & tricks to further improve your annual returns – invest money on a regular basis into your index funds (at least monthly) to take advantage of the dips in the market (translation – don’t only deposit funds once per year when tax season is coming up) and balancing your holdings between all funds once per year (to take advantage of ensuring you are always selling high and buying low), but these are lessons for another day. It’s more important that you just get started now. Even with all this advice, if you procrastinate, nothing can help you because you don’t even have a chance to leverage compounding – you can’t earn if you don’t invest.
There are also plenty of high quality articles written on the topic including this one by MoneySense magazine and a magnificent book that I recommend everyone to purchase called Millionaire Teacher for the ridiculously low price of $15. Within the first month of implementing these tactics, you’ll gain back the expense of this book and then some.
What are you waiting for? Do you accept the status quo or are you always trying to find a better way to accomplish something? Do you want to shave 10 years off your quest to retirement or would you rather work an additional 10 years for no reason at all? I didn’t think so… well then take action today!
–
Brent Mondoux
Founding Partner, Amplified Investments
brent@amplifiedinvestments.com
Amplify Your Investments and Achieve Financial Freedom 
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I think Vanguard has reached into Canada – https://www.vanguardcanada.ca/individual/portal.htm .
Notice the CouchPotato site is now pushing iShares? I haven’t looked into them yet, but I assumed they would be all about e-Series funds.
Finally, in the interest of practicality, I’d be interested on your thoughts on no-fee banking. I looked at my personal and business fees from RBC and I pay over $1100 a year in standard fees! A switch to no-fee banking and a subsequent $100 automatic investment into the mentioned TD e-series funds would be a no brainer.
It’s around the corner…
Yes, Vanguard has now reached Canada, although the annual rates are not nearly as competitive as they are offered in the US.
CouchPotato is indeed pushing iShares now, they are trying to make it as simple as possible for anyone to enter the game (because no matter what, anything is better than sitting on the sidelines).
As for no-fee banking, I use TD Bank and maintain the minimum monthly balance of $3,000 so that I pay no fees (with exception to the $9.99 per purchase of shares in the stock market). Banking fees are negotiable especially if you have assets with the bank (e.g a home mortgage). They already make thousands off of interest income, all you have to do is ask (well okay… insist or take your business elsewhere). Believe me, they’ll bend… the squeaky wheel gets the grease, the quiet ones never get any treatment at all. Also remember this, if they won’t bend you can take your banking elsewhere and other banks will offer you no-fee banking in exchange for your business.
Hope that helps Marc, thanks for your feedback.
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