Mr. Frugal Toque is back! After the success of his first article, people began requesting this second one almost immediately. Although it took him a while, I feel the result is very worthwhile.
My goal with sharing this Canadian information is to highlight a topic that is often overlooked: the expense ratio. Even here in the market-crazy US, people get tricked into buying front-loaded funds, back-loaded funds, actively-managed funds with multiple-percentage-point fees, whole life insurance, and other dubious investments. This persists even with Vanguard standing by to maintain the gold standard for low fees and no hype. And in other countries, fees are often even higher and awareness of their importance even lower.
As a perfect illustration, after I forced Mr. Toque to write this post for you, his research revealed that even his own retirement savings were in an overly costly fund. This new knowledge will allow him to retire earlier and wealthier. In his own words, “Duh! 0.5% of my money, here I come!“
I wish the same for you, regardless of your country.
Canadian Retirement Investing with Mr. Frugal Toque – Part Deux
Previously, on Canadian Retirement Investing with Mr. Frugal Toque (see Part 1), we discussed the two major investment vehicles that are available for private individuals who do not have company or government pensions available to them.
Those were the RRSP and the TFSA. The key difference between those two vehicles is the way they are taxed. Anything you put in an RRSP doesn’t count as taxable income for that year. Instead, it gets taxed when you take it out – after it has accrued compounded investment gains without being taxed on the way. The TFSA is for after-tax income. It also grows untaxed and, furthermore, you pay no tax when you withdraw from it. But enough of the rehash, the real question is:
What To Buy Once You Have the Account
That’s not too hard a question, right? We all know that stock or bond index funds are the way to go unless you think you’re smarter than the stock market (Pro tip: you aren’t, although you can trick yourself into thinking so for surprisingly long periods of time.)
When I started the investment game, I had no idea what I was doing. At the age of 21, I got a job with a salary. My father, a wise man who taught me to fear debt and spend only money that I had, instructed me to max out whatever pension contributions my company would give. At the time, Adm Karpinsk and I worked for a Canadian company that kicked in 50 cents on the dollar up to 5% of our salaries. So we immediately set our pension contributions to 10% of our paycheques(1), randomly picked some funds based on things I’d heard about money(2), and happily took the 5% bonus.
This strategy served me well, and it would probably serve you well, too, so you shouldn’t be ashamed if you got your shit together well enough to get this far. You’d be ‘stashing 15% of your income before it even touched your bank account (automatic!) and you’d be set to retire in some 30 or 40 years. Good for you. At your next raise, you may as well raise your contribution to 13% so you’re at the legal limit (13% from you + 5% from the company = 18%).
But there is some chicanery here and you need to know about it. This game is rigged. Not quite “The Dabo table at Quark’s Bar” rigged, but so damn close you’d swear there’s a Ferengi hiding around a corner somewhere.
You see those mutual funds you’re buying? They have an MER – Management Expense Ratio. This is always shown as a percentage, and it’s the percentage of your money that someone at the bank takes in order to run the mutual fund. When I first set up an account and chose my funds, I paid no attention at all to the MER. I freely admit I didn’t know what I was doing. Once I found out, however, you can imagine my rage.
You see, the MER can run as high as 2.5%. Do you understand how bad that is?
Do you remember the 4% rule? We get that from the fact that the stock market tends to return at least 7% per year when averaged over long periods of time (like my planned 60 year retirement). We leave a generous 3% for inflation and market fluctuation and live off the 4% that’s left.
What happens if you let some jackass take 2.5%? Now you have to live off 1.5% So instead of needing $800k so you can live at $32k per year, you’re going to need to save up $2.13 million dollars.
Yeah. You mad, bro? You should be.
So I did you some research and here’s what I came up with from the national banks in Canada. I could have made this chart larger by including every fund every bank had, but we’re principally concerned with low-cost funds that track Stock Indices and Bond Indices, so that’s what you’ll see here.
For example, from each bank I took the Stock Index fund with the broadest reach of Canadian stocks on the S&P TSX. Each of those funds has, in its definition, the words “S&P/TSX Capped Composite Index ” or something to a similar effect.
I examined the funds offered by the investing arms of the five major Canadian national banks. There are, naturally, other institutions through which you can invest and you should certainly look at your local options. This list will give you a place to start. (Please note that you should obviously consult the actual investment houses in question for their latest rates. The funds available and their MERs seem to be constantly changing and I’m totally not responsible for keeping this chart up to date).
Management Expense Ratios(3)
|Fund Type||TD Trust||Scotiabank||Bank of Montreal (BMO)||Royal Bank||CIBC|
|Stock Index Expense Ratio||0.89%||0.99%||1.05%||0.72%||1.00%|
|Bond Index Expense Ratio||0.83%||0.84%||1.59%||1.22%||1.25%|
That’s pretty straightforward, isn’t it? If you want, you can calculate how many extra years you’re going to have work investing in a bond index fund at BMO vs one at Scotia Bank.
But even if you have a lot of your money where I have it, in Royal Bank’s Stock Index fund, you’re still losing 0.72% of your money to the MER. Instead of needing $800k to retire on, you’re still going to need $975k.
Well, Canada, there are a couple more options for you, if you’re willing to put your toque on tight, ride your dogsled that extra kilometre and deal with a bit more hassle.
The first up on the menu is TD Canada Trust. This outfit offers Mutual Funds in something it calls an “e-series”. I talked to someone who uses them and determined there’s nothing tricky about investing in any of these “e-series” funds. You sign up for an RRSP or TFSA account with TD Canada Trust, select the “e-series” fund called “TD Canadian Index – e” and boom, you have a stock index tracking fund that only charges 0.33% MER. There’s also “Canadian Bond Index – e” at 0.55%
Great. I’ve now got my retirement requirement down to $872k.
And if you wanted to stop there, I wouldn’t blame you. You’re well ahead of the rest of the fools who are subscribing to any of the funds in that chart up there, and at least three wormhole jumps ahead of the idiots back in the Delta Quadrant who are taking payday loans to finance video game consoles.
But this isn’t the blog for just stopping at good enough. This is the blog where we tell you to turn off your car’s A/C and spray your face with a water bottle to save a dollar per driving hour on gasoline. So let’s talk ETFs – Exchange Traded Funds.
You can purchase ETFs on the open market, in which case you have to be careful with things like “turnover rates” which determine how often you need to pay capital gains tax on the increasing value of your funds. If, however, you purchase ETFs inside a TFSA or RRSP account, you obviously don’t have to worry about that.
The benefit of an ETF is an even lower expense ratio. Now that you can buy Vanguard funds here in Canada, there is no excuse for getting ripped off with excessive fees:
See their rates here : https://vanguardcanada.ca/individual/etfs/etfs.htm
We’re looking at 0.12% to 0.15% for basic index funds. That’s great! We’re looking at getting the retirement fund down from that ridiculous $2.14M number to somewhere in the neighbourhood of $825k.
The downside to the ETF is, of course, that you need to purchase it through a brokerage, presumably at the bank where you have your direct investment RRSP or TFSA account.
As a quick aside, a standard way of investing in RRSPs in Canada is via direct deduction from your paycheque. When you set up such regular deductions, the bank is happy to waive any brokerage fees for your continuing business. So even if you’re just putting $100 in six different funds every two weeks, you’re not paying six brokerage fees. With ETFs, you are going to pay those brokerage fees, so you’re going to have to be a bit more careful with your investment schedule.
Some quick research (http://rbcdirectinvesting.com/commissions-fees.html) has shown that these fees are quite low in the current millennium, in the $10 range. Should you use this investment technique with every paycheque? Probably not. Even if you’re investing $600 every two weeks, a $10 brokerage fee is still 1.6% of your money. I would want to save a up a couple thousand in the account before making a purchase, so that the $10 brokerage fee is immediately cancelled out by the benefit you’re getting in lowered MER.
Update: As usual, the readers have one-upped us in the comments, and found a commission-free to buy ETFs – with Questrade – see this link for more details.
Was that as exciting to read as it was to write? I hope so. The overarching lesson here is that Canada is very friendly to all levels of investors, from the savvy MER bargain hunter to the DIY investment champion. What you do is, of course, your call based on your personal levels of confidence and the amount of time you’re willing to spend, but you at least know your basic options.
1 – Yeah, that’s how we spell it up here
2 – Well, that’s what I did. Adm Karpinsk may have been more deliberate.
3 – President’s Choice, I’d love to include you, but I don’t know what the hell you’re doing. Your mutual funds are repackaged mixtures of CIBC’s mutual funds. A month ago, you were charging 2% or more. Now you’re down to 1.x% or so, but why won’t you let me buy straight up index funds?
4 – Royal Bank also offered an S&P TSX Capped Composite Index called the “RBC Jantzi Canadian Equity Fund” which charges 2.11%. Go ahead and compare them and see if you can tell me what you’re paying the extra 1.39% for.
As I said, these rates do change every now and then, so it’s not a bad idea to keep yourself informed.
Royal Bank: http://funds.rbcgam.com/investment-solutions/rbc-funds/index.html
Toronto Dominion: http://tdcanadatrust.com/products-services/investing/mutual-funds/td-mutual-funds.jsp#what-does-td-offer
CIBC is a bit tricky here. I believe I had to click on the link to https://cibc.com/ca/mutual-funds/rprt-gvrnc.html and go to page 101 for the Index Fund, page 43 for the Bond Fund.