Saturday, March 2, 2019

Bank fees are killing your retirement savings.


For a long time now I've been on at least one podcast, and I've had an outlet for all my creative energy.  With the hiatus of Future Chat and East Meets West (this one is admittedly self-imposed), I suppose the time is now to get my thoughts written out so I can stop pestering those around me.

I want to start here by thanking both Planet Money and John Oliver, because listening to Brilliant vs. Boring and Retirement Plans will probably have saved me a couple hundred thousand dollars by the time I'm ready to retire.  Feel free to ditch this post in order to go and check those out, because it's far more enticing than text.

It was actually this past year that I was forced to start an RRSP, and that's when I dipped my toes into the wild world of retirement savings.  I asked about what my friends and co-workers were doing. What I learned was that the threat of fees is not at all common knowledge, and there are equally common misconceptions about the financial advisers that your bank probably offers.

In order to be as clear as possible, I want to go through a few points with you:

Your financial adviser is a sales person.

I once lived with a financial adviser.  Her university background was in the arts, and she took a course offered through her bank in order to be certified to sell mutual funds to her clients.  It was a good job for her.  She was friendly, multilingual, and she was able to afford a nice place in Calgary.

It's often assumed that your financial adviser went to school for business or economics, and is highly trained in these matters.  But they're not.  A bank has sales targets much like a retail store does, it's just the amount of money changing hands is much higher.  And the advice you'll receive is pretty easy to predict, depending on your situation.  In fact, many financial advisers will follow along with an automated process (generated by the bank they work for), in order to figure out what product to recommend to you.  In the case of some banks, they're looking at foregoing the meat bag adviser class altogether and just offering you the advice of the algorithm.

Fees are eating into your savings.

Now, since the bank needs both money for its investors and its workers, all this advice comes with a cost.  It's not a cost you'll be charged up front, or you'd notice as a deduction.  It's usually expressed as a Management Expense Ratio (MER), somewhere on the fact sheet for the mutual fund or portfolio you've chosen.  In the case of Canadian banks, they've probably generated a few index funds, then packaged together those funds in some proportion to create a balanced portfolio.

Quick aside: What's an index fund?  An index tracks something, you've probably heard of the S&P500 for the US market, or the TSX60 for the Canadian stock market.  An index fund just owns the stocks which constitute the index, and it's usually a better strategy than trying to beat, or outperform, the market.  I won't get into how that works here, you should just listen to Brilliant vs. Boring.

So those portfolios, in Canadian banks anyway, will probably come with a MER of roughly 2% on the discounted side of things.  It doesn't sound like much, but that's 2% of your entire savings every year, whether the value goes up or down.  That's right.  If the market takes a dive, the bank still collects its 2% on your money. 

There is a way around this.  Vanguard, effectively a financial co-op, offers a MER of 0.05% for its Canadian stock market index fund, and a little higher for its bond market index (there are other options in this price range, though they are not a co-operative structure).  If you're willing to do a couple hours (max), worth of learning, and perform the trades yourself once a year (and it's best not to touch it more than once or twice a year), you save 1.95% (minus about $10-$25 per trade, which is trivial for a fully funded retirement savings portfolio).  And I'll grant, 1.95% doesn't sound like much to have someone else deal with it for you, but let me present the difference that makes.  I'm assuming you've simply invested in the Canadian stock market, which returns an average of 7% or so per year, and you've decided to put aside $400 a month:

Years passedLow Fees (DIY)Bank FeesDifference
(I don't think the math is spot on here, but you get the idea)

In my case, I have about 30 some years to retirement, and the difference between self-management and bank fees is in the ballpark of over $200,000.  That's a lot of poutine.  It's probably living expenses for a few years, or a nice charitable donation once I've kicked the bucket.  If somehow you've been saving that much for 45 years, you could almost double what your savings with the bank would have been.

Don't try to beat the market.

...Unless you have a nice, stable, juicy pension.  Then have at 'er, it could be a lot of fun.  But if you're counting on the money being there, one company going bust could take a big chunk of your savings (Nortel, Enron, I'm looking at you), or you're paying too much in trading fees (which might be disguised as management fees).  Again, the Planet Money episode "Brilliant vs. Boring" does a great job of explaining this.

Don't be too conservative too early.

Granted, you'll want to really load up on bonds when you're getting close to retirement, or if you're saving and think you might need the money soon.  Bonds tend to fluctuate much less than stocks.  They also tend to go the opposite way of stocks, so they went up during the crisis in 2008, and they have been on the decline during the recent good years of the market.  But for the love of God, don't load up on them early in your saving years, because then you're sacrificing a lot of growth.  This is particularly true if you're in a fund-of-funds bank portfolio, where the MER represents the total of the return from your bonds.  Yes, Shaggy, I'm talking about you, and now the whole world knows that your portfolio is over-exposed in bonds.  How embarrassing for you.

Jack Bogle, for what it's worth, invented the index fund.  His adherents recommend owning your age as a percentage share in bonds.  That way you'll have a nice reliable amount of money when you're ready to retire, but have good income when you're younger.  I'm sure they'd also recommend VCN and VAB, traded on the Toronto Stock Exchange.

So there you have it.  The secret to robust retirement savings.  I'll accept payment in hearty handshakes, and visits to your retirement mansions that you purchased with your saved fees.

You may also feel free to feed me.