Convert your high priced Mutual Funds to lower cost Discount Funds and save up to 45%
My friend Terry asked me the other day, could he start a self directed account by simply transferring in some or all of his existing Mutual Funds ? He wasn’t ready to take over the management of his investments by choosing Exchange Traded Funds (ETFs) to replace his Mutual Funds quite yet.
And then it hit me. What a great idea as a way to comfortably begin to Self Direct one’s investments, and save 45% on fees at the same time, without having to change a thing. I have spoken to hundreds of retirees who feel that they are getting ripped off by the high fees that Canadian Mutual funds are charging (2+ % for sub index performance), but just don’t have the knowledge and confidence to take over the management of their investments.
But what Terry was asking made a whole lot of sense because, many Canadian Mutual Funds have a “series” of exactly the same funds for sale through discount online brokers, and at fees (Management Expense Ratio or MER) about a full 1 per cent lower than what they charge when the same fund is bought through banks or commissioned brokers or advisers. That’s because those salespeople get the 1% per year as a “Trailing Commission” which of course you are never told about. With the average Canadian mutual fund charging 2.2% fees, a 1% reduction equals a 45% savings !
Mutual funds bought through banks or commissioned brokers charge 2.2% fees on average
Let me explain. Mutual Funds bought through banks or commissioned brokers/advisers are classed as “A” funds, and most charge a MER fee of 2% +. But in many cases, the exact same fund can be bought through a discount broker as a “D” fund, with a MER about 1% less. Full disclosure – there are also “F” series funds which charge about the same MER as the “D” funds, but are only available through fee based advisers, who will charge you 1% or more to manage your investment account, so you are right back in the 2%+ fee level.
2% fees can equal a 44% reduction in wealth after 20 years
Now, you might think that a 1% or 2% fee does not amount to much. But you would be wrong. Have a look at this graph which shows that after 10 years, a $100,000 investment in a tax free account with a 2% fee returns $40,000 less than an index fund returning the S&P 500 average return of 9%. After 20 years, the difference is $170,000 (because of the magic of compound growth). By saving even 1% of the fees, you could have an extra $19,000 after 10 years, and an extra $79,000 after 20 years.
And the problem is that most Canadian mutual funds underperform the market because of those fees. For example, Standard and Poors Index versus Active (SPIVA) reports that as of June, 2018, 89% or more of Canadian managed equity mutual funds underperformed their index. See the report here: SPIVA Canada
So, here is the way around this for first time Self Directed investors.
First, check to see if your Mutual Fund is available in a “D” series. This information is available on your fund company’s website under the Fees and Taxes heading.
Second, once you have established that a “D” series of your Mutual Fund is available, open a Discount Online Brokerage Account. The simplest approach is to open an account with the Bank that you do most of your banking with. Set up an appointment with an Online Brokerage specialist and they will sit with you and do all of the paper work to open an account, and link it to your bank account. Or you can easily open an investing account online by going to their website. It only takes a few minutes. Ensure that your new Investing account will cover the transfer charges from your existing account, usually about $150 per account. Today, many will offer 50 or 100 free trades in addition to those opening a new account and transferring in investments or cash.
Third, transfer some or all of your Mutual Funds to the Online account. Again, the bank’s online advisor can show you how, or there is a simple online form.
Fourth, get prepared for your former broker/adviser to call you and tell you why it is a terrible idea for you to save 1% and cut him out of his commission. Draft a resistance speech while you think about the money you will be saving.
Fifth, as soon as the Mutual Funds arrive in your new Online account (it will take a week or so – your former broker won’t be in a hurry to lose you), call the Online Brokerage phone assistance and ask them to convert the Mutual Funds to “D” series. There is no fee or tax implications to do so.
Sixth, enjoy saving 1% in fees every year (45%) for exactly the same investments that you previously were paying your adviser for. And enjoy joining the growing but still somewhat exclusive club of self directed investors.