Could a simple and easily avoidable investment mistake cost you the price of an average house? It turns out it can.
Beyond fundamental analysis and market outlooks, long-term investing is about the creation and maintenance of good investing habits. Certain habits, such as avoiding the urge to sell during a market crash or avoiding an overpriced stock when investors seem overly excited about it, are well understood. Others, such as avoiding high fees, are not talked about often.
Here’s a look at how reducing the costs of investing could have a disproportionate impact on your long-term performance.
Basis points
Long-term investment performance is usually measured in single-digit percentages. The TSX 60 Index has compounded at an annual rate of 7% over the past decade, while the average investor tends to perform roughly in line with this rate over the long term.
Due to the power of compounding, even a low single-digit rate of return could generate substantial wealth over several years or decades. However, this also means that every basis point (one-hundredth of a percentage) could make a big difference.
The issue is that wealth management firms tend to charge several basis points in fees for their mutual funds and exchange-traded portfolios.
According to research by Morningstar, the median expense ratio for equity funds in Canada was 1.98% in 2018, one of the highest rates in the developed world.
Digital wealth manager Nest Wealth took this research and tried to estimate the total impact of these exorbitant fees. They found that the average investor who starts off with $10,000 at the age of 25 and deploys a few thousand more every year will spend nearly $323,654 over the course of her investment life (39 years).
In other words, investment costs over the long term could be on a par with the costs of childcare or home ownership in Canada.
The solution
Fortunately, a solution to this issue has emerged in recent years. Technology has reduced the costs of investment management and portfolio creation, with some fund managers and investment platforms eliminating fees altogether.
Vanguard and Charles Schwab both cut trading commissions to zero last year. Meanwhile, the management fees on exchange-traded funds (ETFs) and index funds have moved closer to zero as well.
The management expense ratio (MER) on the iShares S&P/TSX 60 Index ETF is 0.18%, far lower than the average Canadian mutual fund.
South of the border, management fees are far lower. The Fidelity ZERO Large Cap Index charges no management fees on its simple TSX Index fund. The Schwab S&P 500 Index Fund costs a mere 0.02% in management fees.
By simply switching to low cost Canadian index funds or free U.S. ETFs, you could save hundreds of thousands of dollars in potential fees over the course of your life, perhaps funding a more comfortable retirement or a second home with your savings.
Foolish takeaway
Investment fees are a silent drain on your wealth. By switching to low-cost alternatives or U.S.-based funds with relatively reasonable fees, you could save a lot of money by the time you retire. It’s an easy way to boost your overall performance without much time or effort.
