Tag: Vanguard

MER – Cheaper is Better

The management expense ratio (MER) is the percentage of your portfolio that you pay to the company that sells you the index fund, exchange traded fund (ETF) or mutual fund that you hold in your portfolio. The fees for these products must be disclosed to potential buyers. Thanks to the wonder that is the internet, you can easily do an online search of any mutual fund, index fund or ETF and find its MER.

Generally speaking, mutual funds are more expensive than both index funds and ETFs. I’m not entirely sure why other than to say that mutual funds are actively managed. This means that there are a whole lot of people who are researching and analyzing data before doing a whole bunch of buying and selling of various stocks for inclusion in the mutual fund. All of those people need to be paid. There’s a lot of overhead that must be covered by fees from clients in order to ensure that all of that activity is performed.

In sharp contrast, index funds and ETFs are passive investments. They simply buy into the top companies that meet their investment objective and then it’s done.

You’ll have to do your own research before you in invest. You can also speak to a fee-only certified financial planner. However, my general advice to most people is the following. If you have the choice of buying a mutual fund or an index fund/ETF, go for the lower cost product so long as you can still achieve your investment goals. It will be cheaper for you in the long run and you’ll wind up with more money in your kitty.

Take a look at the following MER calculator. It allows you to do a side-by-side comparison of the impact of paying a higher MER on your portfolio. You can control so many variables: your investment horizon, the MER, your starting balance, the assumed rate of return, and your contribution amount.

See for yourself…

Start with an investment of $1000 in both Fund A and Fund B. Assume that they are both identical and both of them will help you achieve your long-term financial goals. Commit to contributing $50 per week into your portfolio, which is $2600 per year.

Enter an annual average return of 7% for both funds. And assume that you’re going to be investing this money for 30 years. The average life expectancy is roughly 80 years for humans. Believe me when I tell you that 30 years is not an unreasonably long investment horizon.

Here’s where the steak starts to sizzle. Fund A is a mutual fund charging a measly 1.5% per year. In other words, Fund A skims off 1.5% of the value of whatever’s in your portfolio. Fund B is an index fund, or an ETF, which is charging a minuscule 0.05%. Go ahead – plug those numbers into the formula.

Now, hit the calculate button. What do you see?

Fund A – with the higher MER – is going to cost you $37,330.78 in fees. On the other hand, Fund B – with the much lower MER – is going to cost you $1,244.36.

That’s a difference of $36,086.42 in fees. This is money that is not staying in your investment portfolio since it’s being paid to someone else. Why would you want to pay this amount if you didn’t have to?

Play with this calculator – change the variables – see the impact of higher MERs over a longer period of time. I think you’ll agree with me that when it comes to paying for investment products, the MER matters – cheaper is better.

Hold up, hold up, hold up!

Blue Lobster, are there really investment products that pay 0.05% in MER?

Yes, Gentle Reader, there are. At the time of this post, the website for VanguardCanada is showing two equity products – VCN and VCE – with MERs of 0.05%.

*** To be clear, I am not being paid by Vanguard Canada for mentioning these investment products. I do own units in VCN.

All else being equal, cheaper is better. For simple comparison, the Big Six banks in Canada sell mutual funds that are equivalent to VCN and VCE. At the time of this post, the MERs on their products are much higher than 0.05%.

I have to amend my earlier statement. At the time of this post, the links for CIBC and HSBC do not disclose the MERs for their equity products. To find the MERs for their products, you will have to do a bit more hunting-and-clicking but you’ll get there. The other 4 banks disclose this information on their website with one-click. This tells me that atleast 4 of the 6 big banks are willing to ensure that their customers can easily find the right information to make an informed choice.

Now you know better.

Paying a higher MER means less money in your pocket at the end of the day.

As a general rule, cheaper is better when it comes to assessing the MER of equivalent investment products. I want to be clear that you shouldn’t base your entire investment decision on the MER. It is a significant factor, but it’s not the only one.

You still have to determine your investment horizon. Is this money for a short-term goal or a long-term goal? If long-term, MER should be given more weight in your decision-making.

Are you comparing equivalent products? An index fund that invests in short-term bonds should not be compared to a mutual fund that specializes in gold and diamonds. The risk profiles of the two products are vastly different. It is reasonable that they would have different MERs so this factor should be given less weight at decision-time.

It is a serious money mistake to pay a higher MER. If you want to really blow your mind, go back and change your starting balance to $10,000 and your annual contribution to $5,200. The disparity in MER cost grows to $83,130.29! And if you extend your investment horizon out to 50 years, then you’re saving yourself $442,979.28! Wouldn’t you rather have that extra money in your portfolio in 30 years? I know I would!

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Weekly Tip: Track all your expenses so you know where you spend every dollar. Despite my constant admonitions to save-and-invest, I know that most people enjoy spending money. However, I want you to be 100% confident that you’re spending your money on things that make your life better. Tracking your expenses is one way to do this. If you see that you’re spending money on things that don’t bring your joy or that make your life worse, stop buying those things. Easy peasy – lemon squeezy!

Consistency is One of the Keys

This week, I listened to a story that blew my mind! It was a testament to the power of consistency in investing, through good times and bad. Diane was her name – a lady in her 60s who’d survived divorce from an alcoholic, while raising 4 kids, taking 8 years to get her electrical engineering degree, and starting her professional life at age 42. By the time she’d retired, Diane was worth $5,500,000…. and did I mention that she never earned more than $82,000 per year?

Check out episode 99 on Millionaires Unveiled to hear the rest of her story, a podcast that has recently caught my attention. They focus on interviewing millionaires and the stories are fascinating.

The Financial Independence Retire Early (FIRE) community loves to tell stories about people who figured out who to make a lot of money quickly in order to retire in their 30s and 40s. And to those who can do it, I say “More power to you!”

I would have loved to have retired in my 30s too, but that wasn’t the way that my cookie crumbled. I learned about the FIRE community in my 30s, though the regular channels – Mr. Money Mustache – and went from there. However, no one has been able to teach me how to turn back time so I’ll be retiring in my 50s.

What I loved about Diane’s story is that she had challenges in her life, including cash-flowing college for her children. I mentioned that she had 4 children, but did I tell you that there was a 16-year spread from the oldest to the youngest? Diane was paying for college for 16 years straight and she still wound up debt-free with over $5Million in her kitty.

How in the hell did she do it?

Consistency is the key. Throughout her podcast, Diane emphasized that she and her husband saved atleast 10% of their income throughout their working lives.

Single People, please don’t roll your eyes at this point. Kindly avoid the trap of believing that it’s-easier-if-you’re-married-because-there-are-two-incomes! Diane was very clear that she kept her money separate from her husband’s.

In other words, the money that she has not is solely Diane’s money. Being single is not an impediment to becoming wealthy. It’s possible to become a millionaire even if you don’t become a spouse.

Diane committed to saving 10% of her income from the time she started working in her 20s. At the time of the interview, she was in her 60s. That’s 40 years of investing in the stock market! Diane mentioned that she’s been told to allocate her funds into a 60%-equity & 40%-bond portfolio, but she prefers to keep 70% in equity and 30% in bonds.

That’s two lessons we can take from her story. She chose to save something every payday by living below her means and she invested her savings in the stock market. Time in the stock market helped her investments to grow.

The third lesson from Diane’s story is that you don’t need to make a six-figure income to do what she did. Diane never earned more than $82,000 while she was working. I’ll agree that she earned more than the median income for the average bear, but keep in mind that she was raising children on this income. It’s reasonable to assume that the costs of childrearing ate into whatever was left of her income after she’d set aside her savings.

Creating Wealth for her Family

Diane has also set an example for her children, one that they will hopefully pass down to her grandchildren. Through her actions, Dians has shown her children that consistency is one of the keys to building wealth and that saving money has to happen no matter what. If I understood her correctly, Diane already had children by the time she returned to school at age 34 to study electrical engineering. She worked full-time while studying, and she graduated at age 42. Throughout those 8 years, Diane continued to save and invest from every paycheque like clockwork. At the age of 50, Diane was divorced…and she was worth a cool million dollars. The rest of her money came from the compounding over the next 15 years!

Creating a multi-million dollar nest egg was the first step towards ensuring an intergenerational transfer of wealth within her family. If she chooses, Diane can pay for the post-secondary educations of her grandchildren. By alleviating this financial burden, Diane would effectively be helping two generations of her family. Her children could invest their money towards their financial security and her grandchildren could study and graduate without the burden of student loans. If they are wise, Diane’s children will then use their money to pay for the educations of Diane’s great-grandchildren when the time comes so that the grandchildren can build their wealth.

Do you see how beneficial this cycle of intergenerational wealth can be? Diane’s example of consistently saving and investing for decades is a gift to her children, if they choose to follow it.

Save. Invest. Learn. Repeat.

Just like the rest of us, Diane won’t live forever. It’s time for her to enjoy some of her money while the bulk of it continues to compound and grow. According to the podcast, she is using her money to fulfill her dreams of travelling with her family and creating lasting memories. Good for her!

If you haven’t already started to save and invest, then start today. Open a savings account – set up an automatic transfer so that you save something from each paycheque – invest in the stock market through a broad-based index fund or exchange-traded fund. Live below your means so that you have the money to invest. Save – invest – learn – repeat.

There’s nothing to suggest that Diane had the ability to spend all of her money on her own personal priorities for her whole working life… I’m looking at your Single People Without Children. If you’re a Singleton, then you’re the only person making decisions about where your money should go, which of your dreams to fund, how much you’re willing to invest so that you can create a retirement nest egg for yourself.

Ignore the talking heads in the media. They deliver nothing but a steady stream of hype-and-fear in order to drive ratings. “It’s time to buy! It’s time to sell! It’s time to buy! It’s time to sell!” They have no personal stake in whether you achieve your goals or not, so ignore them.

Saving a little bit of money at a time and investing that money in the stock market will lead to more than a million dollars after a few decades. While your money is working hard for you in the background, you go about the business of living.