Why Investment Management Fees will matter more in the next ten years.

The S&P 500 is up 155% since 2012, but that is unlikely to continue.

XIC vs VFV
VFV (US S&P 500 in C$ ETF) versus XIC (TSX 300 in C$ ETF)

We have been in an economic expansion since 2009. Similarly, the stock market, at least the US market, has been on a phenomenal growth tear over the same period, increasing by an average of 13% per year plus dividends for a total of 14.7%. (The Canadian market, by contrast has done virtually nothing, (see above graph) proving once again that 1. diversification is key to investing success and 2. business unfriendly policies do not provide for economic growth. But I digress.)

Investment returns always return to “the mean”. They have to.
The problem is that the long term average total return (the mean) for the US stock market is about 11% including dividends, and unfortunately there is a law of statistics called “Reversion to the Mean”. That indicates that if you have years of above average growth they will inevitably be followed by years of below average growth. And that is where we find ourselves today.

Some pundits suggest that we are in the ninth inning of this stock market.

Of course, no one knows how long the current ball game will go on. Some very competent economic pundits such as David Rosenberg state that we are in the ninth inning and that the game is drawing to a close. However, there is no need to guess. Looking at the data we can see that if US stock markets over performed by 3.7% for the past nine years, those markets must underperform by the same amount or more over the next 9-10 years. So the arithmetic indicates that we are looking at average returns of around 7% per year if we are lucky. And I think that is optimistic as long as Trump is President, for reasons that I will not go into here.

Canadian managed mutual funds charge some of the highest fees in the world.

If you are invested using high priced Canadian based managed equity Mutual Funds, you are paying 2% plus per year in Management Expense Ratio (MER) fees. Here’s the bad part. Despite the assurances of your advisor to the contrary, according to S&P Indices, 98% of Canadian based managed US equity funds underperformed the market over the last ten years. This despite protestations on BNN, CNBC and elsewhere that this was a “stockpicker’s” market. Well, if so, then they were pretty poor stock pickers. For the details, see the report here:
SPIVA S&P Index versus Active

Future returns minus high fees and inflation leave very little for the investor.
Back to arithmetic. 7% less 2% fees less tax at 20% in a taxable account less 2% inflation leaves you with a grand total of 2.0%. That is not going to provide the kind of real income over time that retirees want to pay for travel, the house someplace warm, or even the cost of a retirement residence when you get really decrepit.
The solution – keep fees as low as possible by investing in passively managed, index tracking Exchange Traded Funds (ETFs). For example, a typical US market index ETF has a management fee of .05% per year. Here are some examples from the biggest ETF providers in both US$ and C$:
ETF      ISSUER            MER%         Currency        Hedged
VOO    Vanguard          .04                 US$                     No
SPY      StateStreet        .09                 US$                     No
VFV     Vanguard          .08                 C$                        No

XSP     IShares               .11                 C$                        Yes

ZUE    BMO                    .10                 C$                         Yes

Keep it simple, keep it low cost.

Have you heard of the KISS (Keep it ssimple) method ? Warren Buffet, Chairman of Berkshire Hathaway and one of the most successful investors in world history, had this advice for the executors of his estate. “Put 90% in a low-cost S&P500 index ETF (such as Vanguard) and 10% in a short-term bond ETF”. Interestingly, over the past 10 years, his company’s stock BRK.A has just equalled the S&P500, despite years of toil and many brilliant managers. KISS still works.

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