Whether it’s groceries or clothing, a new car or college education, when you go shopping, you probably at least glance at the price, right? You may not always go for the cheapest choice, but if you’re going to spend more, you expect to get more in return.
And yet, I sometimes see people skipping this critical comparison when it comes to their investments. That’s why today’s “No Dumb Question” is dedicated to:
It’s not that people don’t care about investment costs. It’s just not always that easy to wrap your arms around them. Fortunately, by familiarizing yourself with the most common costs, you’ll already be ahead of the game on this important, “No Dumb Question.” Let’s get started on some of the big ones.
Quick question: What’s the last purchase you made? Groceries? Filling up on a tank of gas? Hiring a plumber?
Whatever it was, odds are you at least subconsciously considered all of the costs, and picked accordingly. For example, you may have been willing to pay more for a licensed plumber over a handyman, while opting for a generic cold medication if the brand name was twice the price.
Whether you realize it or not, you’re not just looking at the sticker price when you go shopping. You’re also thinking about those indirect impacts of your choice.
The same holds true for your investments. Since every dollar of investment expense is one you don’t get to keep as your own, it’s easy to see why you’d want to compare all of the costs involved. But what are all the costs worth considering?
Let’s first look at those proverbial “sticker prices,” or your direct investment costs. These are the obvious ones that, like the price of a litre of ice cream in the grocery store, are pretty easy to spot. There are at least three of these: direct trading costs and Management Expense Ratios and Advisory fees.
First, whenever you buy or sell a stock, bond, mutual fund, ETF, or any other investment, you’ll usually pay a commission or broker’s fee to place the trade. These costs are typically disclosed in the trade confirmations you receive from your bank or the custodian where your investments are held.
It is worth ensuring that your custodian’s overall fee schedule is in line with the competition.
There’s another important thing you can do – or actually not do – to minimize your trading costs. Don’t trade any more than you must! Remember: The less you trade, the less you will pay in trade costs.
Now, to that second kind of direct investment expense: Management Expense Ratios or MERs. Unless you’re trying to pick individual stocks and bonds on your own, chances are you’re invested in managed products like a mutual fund or your are invested in exchange-traded funds … or ETFs. For reasons I’ve covered in a past “No Dumb Questions” “What is an index fund” sensible, low-cost funds are usually the best way to go for most investors. But, just as a plumber earns his or her keep with a labor charge, a fund manager earns his or her living by charging MERs. And keep in mind…these are additional, separate costs from a management fee paid to your financial advisory firm.
MERs aren’t quite as obvious as trading costs. In fact, they will not show up in your monthly investment statement. Instead, they’re reflected in slightly lower share values. Say, for example, your $10,000 investment in a pool with a 0.5 of 1% MER has grown to $12,000 after three years. Had there been no MER, your investment might have grown to, say, $12,170 instead.
You can find a fund’s MER directly disclosed in its legal prospectus and other places like Morningstar.
As a rule of thumb, I would look for pools that have MERS well below 1%.
Another important direct cost is the fee you pay for advice where you have engaged an advisor. This fee is now required to be reported to you each year in dollars and cents, and represents what your advisory firm is paid to provide you advice. This is fee often varies with the size of the amount being managed.
In a future post, I’m going to go over what you should expect in return for that fee…but here’s a spoiler: you should expect a lot.
In general, understanding your advisory fees, MERs and brokerage fees are costing you are great first steps. But as I’ve been hinting, the sticker price doesn’t always tell the entire tale. To spot the difference between good value versus cheap product , it helps to also understand the indirect costs involved.
