Beat The Bank: Understanding How Investment Fees Work, with Larry Bates
Welcome to The MapleMoney Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. I’m your host, Tom Drake, the founder of MapleMoney, where I’ve been writing about all things related to personal finance since 2009.
It might be hard to believe, but many Canadian investors lose as much as 50% of their returns to fees. In fact, the high cost of investment fees can have a six-figure impact on their investment portfolios over the long term. Are you one of them?
My guest this week is Larry Bates, a former bank executive and author of the book, Beat the Bank: The Canadian Guide To Simply Successful Investing. Larry joins us to discuss why Canadians are losing so much money to investment fees, and what we can do about it.
According to Larry, much of the problem lies within the investment industry itself. Banks and investment firms have a very expensive distribution network, leading to high investment fees, which are required in order to generate and maintain their profits. So, while investment advisors themselves are good people, they’re often left selling bad products.
Thankfully, there’s a better way. Low fee alternatives, such as ETFs, hold the same stocks as most actively traded mutual funds, at a fraction of the cost. In fact, traditional mutual funds can be more than 20X more expensive than their ETF alternative. The problem, as Larry puts it, is that banks aren’t educating clients on these cheaper alternatives, even though you can usually buy them from your primary financial institution. We discuss this, and a whole lot more, right here on The MapleMoney Show.
The biggest myth about robo advisors is that they are completely tech driven, and lack the personal touch. If you’re curious about signing up and have questions, our sponsor, Wealthsimple, now lets you book a 15 minute call with an experienced portfolio manager. Head over to Wealthsimple Chat to book your appointment today.
- Is investing really that complicated?
- Did you know? Over 5 million Canadians own high cost mutual funds
- Why the investment industry is addicted to high cost funds
- Investment advisors are very good people selling bad products
- Knowledge is power when it comes to investing
- Buy low, sell high: Human nature drives us in the opposite direction
- Most investors don’t capture the market returns
- Business ownership is the greatest wealth creator in the world
- Most fund managers performance is equal to the market BEFORE fees
It might be hard to believe but with many Canadian investors there’s more than 50 percent of the return on fees. Are you one of them? My guest this week is Larry Bates, a former bank executive and author of the book, Beat the Bank – The Canadian Guide to Simply Successful Investing. Larry joins us to discuss why Canadians are losing so much money to investment fees and what we can do about it.
Welcome to the Maple Money Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. The biggest myth about robo-advisors is that they’re completely tech-driven and lack the personal touch. If you’re curious about signing up and have questions, our sponsor, Wealthsimple, now lets you book a 15 minute call with an experienced portfolio manager. Head over to maplemoney.com/wealthsimplechat to book your appointment today. Now, let’s talk with Larry.
Tom: Hi, Larry, welcome to the Maple Money Show.
Larry: Hey, great to be here.
Tom: Your book has been out about a year now. It was very eye opening to some of the things that go on behind the scenes that most people don’t realize. I didn’t realize some of them as well. Just to hop right into it. I mentioned it before my podcast but a long, long time ago when I was starting to invest. I thought I knew better so I went and got some mutual funds because I figured, this is what you’re supposed to get. That’s where I had my mortgage so I just went into that bank and selected one mutual fund at the time, but then I started to build it out. Why did people do that? Why did they head to their local bank and just get sort of whatever is available?
Larry: Well, as Canadians settle from birth for we’re trained to trust our big institutions, including the big banks and other investment providers. The investment industry portrays investing as super complex. And their message is, “Hey, Tom, this stuff’s really dangerous and way over your head. Don’t even bother trying to figure it out. Just come see us and we’ll take care of you.” And most Canadians do that. In fact, five million Canadians own high cost mutual funds. Mutual funds are the tool that most Canadians use to invest in the stock market. Why? Because that’s what they’re told to do. There’s nothing wrong with mutual funds in principle. The problem is that most charge fees of one and a half to two and a half percent a year, which adds up to stripping out about 50 percent of market returns over many years. So most Canadians are taking 100 percent of the market risk, but only getting to keep about 50 percent of market returns. And that has a huge impact on ultimate retirement nest eggs.
Tom: It’s interesting math looking at it that way. I think some people see that they’re only paying 2 percent. I did the same. I was thinking two out of 100 isn’t bad, but it’s really two out of your return. Maybe you’re getting that 7 percent return if you’re lucky.
Larry: Two out of 100 isn’t bad. But if you’re paying that two percent every year for 30 years, that’s 60 out of 100. So the math changes. Again, the impact is huge but it doesn’t have to be that way. There are fabulous low-cost investment products out there like index ETFs and lower cost providers like robo-advisors that present great, lower cost alternatives for Canadians. It takes a bit of time to learn investment basics to take advantage of these lower cost routes and keep more money in their retirement accounts.
Tom: That was something that was really eye-opening for me at the time—this idea that you can invest in ETFs and build a portfolio. Like the couch potato portfolios it’s pretty common for ETFs. Then you’re investing in the entire market but you’re not paying these fees for some mutual fund manager to manage this for you. It’s kind of just going with the flow.
Larry: Well, yeah, and most of the large mutual funds own the big stocks—the big name Canadian stocks, U.S. stocks that the ETF also hold. So the low cost index ETFs are just a less expensive way to invest in the same ultimate stocks that the mutual funds hold. The difference is the fees can be about 20 times lower. And who gets to keep the difference? You do. Now, in order to use some of these lower cost alternatives, you just need to take a bit of time to learn investment basics. Investing can be very complicated. The industry likes it that way. But it also can be really amazingly simple if you take a bit of time to learn the basics and keep it simple. In fact, the simpler the better.
Tom: And that’s just it. When I had mutual funds, it became this sort of thing where I was trying to create my own portfolio. I knew I needed this mutual fund to cover dividends, and this mutual fund to cover some wild thing—some really small countries or something like that. The more I tried to build this up to have this very diversified portfolio, what I found was, the more unique the mutual fund, the more the rates just kind of keep going up.
Larry: Our banks and institutions in many ways are very good at what they do and in many ways provide good service. In fact, they offer these lower cost products if you know how to get them. But the Canadian banks are world class at charging fees. They know how to charge. And for the most part, these fees are not paid directly by investors. They’re just sort of quietly deducted, literally, sometimes every day from retirement accounts. And that adds up to a huge numbers over time. There are great ways to deal with it and keep more.
Tom: So why do we gravitate toward these? Is it just convenience or do people think they’re getting something more there when they pick up these more expensive mutual funds?
Larry: First of all, the industry is really addicted to these high cost funds. That’s the way they generate the revenue profitability. They want to grow their profitability every quarter. And the banks and the big investment firms have these thousands of advisors across the country—a very expensive distribution network. They have to charge these high fees in order to generate and maintain their profits. And the advisors themselves, in order to maintain their targets and keep their jobs, have to sell these high cost funds. So advisors generally are good people. They’re just selling really bad products. They’re not working in the interests of investors when their own institutions can be offering products through a different arm at a 20th of the cost. But they’ll recommend the high cost products.
Tom: Yeah. And certainly, yes, there are great advisors at banks. There’s a sort of bias issue where…
Larry: Where they’re forced to sell this high cost product which is it just is a system that doesn’t work for the benefit of Canadians.
Tom: Do you know if they’re commission based? I’m not sure.
Larry: Different advisor models have different compensation structures. I think most people who work in bank branches are probably not paid directly commission, but they’re certainly compensated at the end of the year. Their bonuses are tied often to how much business they bring in and so forth so it’s their job is to sell these high cost products and the industry makes multi, multi tens of billions of dollars a year from this. Again, they don’t serve Canadians well. At the same time, if you take a bit of time to learn the basics and know which door to go through, the same banks and other institutions offer super, low-cost, super efficient, great products that you can take advantage of if you know a few of the basics.
Tom: You touched on robo-advisors. Wealthsimple is the sponsor of this show. I’m a big fan of robo-advisors, especially for people starting out. I realize they charge an extra fee. And that should be known. But your portfolio grows and grows that’s going to start to matter more and more. For someone looking to start investing, I think robo-advisors are a great option compared to going to your local bank.
Larry: I couldn’t agree more. I think robo-advisors are a great option for millions of Canadians who are starting out or the five million Canadians who own these high-cost mutual funds. That’s a good option. Yes, they charge more than an investor who chooses to buy low-cost ETFs directly, but much, much less expensive than mutual funds. So it’s a great option for those who want to make a change, keep more money in their pockets but don’t want to go all the way and do it directly themselves.
Tom: Yeah, investing in stocks or ETFs in this case is still a little intimidating. You can open up with a broker…
Larry: Fear is a big factor. Why is there fear? The industry portrays investing as dangerous. That’s one thing. But really, it’s a lack of knowledge. Knowledge is power. So gain a little bit of knowledge. That’s what my book is about. It’s aimed at helping Canadians. Gain a bit of knowledge and that fear will dissipate. Even if you choose to stay with your existing advisor or bank or whatever, you’ll be a much better informed consumer and that will pay off.
Tom: Speaking of being poorly informed, one of my confessions in the past has been that I made my decisions on which mutual funds I was going to hold, especially at the very beginning when I was just picking one or two, based on past returns. I sort of went with what was high performing. What’s the danger in that?
Larry: Well, I’m not sure of the exact numbers but there are many, many thousands of mutual funds in Canada. Now, you can imagine that some of them at any given point time will have really performed well in the last couple of years. And those are the ones that the industry markets and advertises. The problem is, recent past good performance by a fund or a fund manager is not predictive of future performance. What tends to happen, unfortunately, is advisors and individual investors tend to recommend recently high performing funds which are more likely to underperform in the near future. That’s the math. So they’ll buy the high performing fund that might underperform, flip out of that and buy the next high performing fund and keep going on that sort of spinning wheel and actually end up massively underperforming the market. There have actually been studies done which show that thousands of Canadian advisors recommend this exact strategy for their clients. And even the advisors themselves for their own portfolios are massively underperforming the market and would be way better off just investing for the long-term. A lot of people look at the stock market thinking they’re going to get in, get out, buy low, sell high. Human nature drives us in the other direction. When the market is tanking we want to sell. When the market is high we want to buy. Human nature drives us to buy high and sell low—the opposite. Again, studies show that most investors don’t capture the market returns because they actually try to get in and out of the market at the wrong times. The way I look at the stock market is as a tool to be a long-term business owner. Business ownership is the greatest wealth creator in the world. The stock market allows anyone with a few thousand dollars to be a business owner. If I own 100 shares— or even one share in RBC, Bell, Apple or whatever it is, I’ve got thousands of people going to work for me every day. All I have to do sit there or not. I can do whatever I want. It’s a fantastic vehicle to enable people to be business owners and to participate in the capitalist system. Even if you don’t necessarily believe in it and despite what your political views might be, you can take advantage of that. Look at the market as a way to become a business owner. Forget about the noise in the market day-to-day. It goes up and down. It’s the long-term ownership over a long period of time that creates wealth.
Tom: I’m very good at buying stocks and not looking at them almost to a fault. There’s been some times where I’ve looked in my account and say, “Oh, that one really dropped.” But in general, I do buy and hold mostly ETFs, but sometimes stocks. I do like to pick some sort of traditional Canadian dividend stocks and buy on the bad news. I know that’s not where our emotions lead us to. People do get in and get out, but I do just kind of consider that a sale and buy then. But it’s rare. I don’t have a lot of dividends. It’s mostly ETFs because I think that’s a much better way to go. You mentioned this idea of people hopping in and out and stuff. When you buy an ETF you know you have everything. And I think that probably helps people just hold onto it.
Larry: Richard Thaler won the Nobel Prize a couple of years ago in economics. He said Rip Van Winkle would have made a great investor. He’d have invested before his nap and then 20 years later when he woke up, he’d be happy. For most investors, they shouldn’t be trying to play the market. Just invest in diversified low-cost, ETFs or other vehicles or stocks and stick in for the long-run and ignore the market ups and downs.
Tom: People that are invested in mutual funds spend their two percent and they know they’re spending it. Maybe they know there’s ETFs out there and they’re still sticking with their mutual funds. Is it sort of this idea that they’ve got this professional portfolio manager that’s managing the mutual fund and is doing something active and helpful with their fund?
Larry: Well, certainly the industry advertises and markets the idea that their fund managers can pick the stocks that perform and avoid those that underperform. But study after study after study shows that mutual funds underperform market averages. One reason being, they’re not very good at picking the best stocks and avoiding the bad ones. The biggest reason is they can’t (over time) overcome the impact of fees. So overall, in aggregate, mutual funds underperform the market by a huge margin despite what the marketers have to say. And the best advice for most investors would be to invest through low-cost routes, maybe index ETFs, maybe a robo-advisor. Get a diversified portfolio, which is super easy to do as you know and as I outlined in my book. Keep the fees low and you’re going to beat 95 percent of your friends and neighbors.
Tom: You’re right that it’s simple. I like the couch potato format of four ETFs, but now there’s literally a single ETF that can do this for you.
Larry: There these great all-in-one ETF products now where you just select the ratios of conservative bond portion of your fund versus the potential stock market portion of your portfolio. Pick the ratio that makes sense for you and you can buy a single ETF that matches that. And that can be your single investment you own. Underneath that ETF is a globally diversified fund that matches your risk profile and your goals long-term. So it can be super easy and super low-expensive if you learn a few of the basics.
Tom: I think that takes out one of the issues of dealing with a broker is the idea that you have to rebalance. If you do it monthly, quarterly, or annually it’s just something that is one less barrier to getting started and continuing with it.
Larry: Yeah, they’re great products for average investors.
Tom: You mentioned this idea of how the fees just kind of drag down these professionally picked, actively managed, mutual funds. I’ve always liked considering the idea that there’s so many mutual funds out there that are holding so many dollars in them that really, they are the market. So on average, how can they not be the average of the market? And yes, the fees coming off that average?
Larry: They’re aggregate performance is going to match the market by definition because they are the market. And then when you knock the fees off, that means they’re going to underperform. And again, that’s where five million Canadians are. Some are aware of that but I would say most Canadians are unaware of the extent of fees that are being charged indirectly and deducted from their accounts. And they’re certainly unaware of the impact that those fees have over time. As I mentioned, most Canadians only get to keep about half of the market return and giving half their returns in fees. That makes no sense. Basically, what I’m saying is a two percent fee really is a 50 percent fee. It’s madness. Would you pay a real estate agent 50 percent of the gain on the value of your house over 20 years? It’s nuts. So 10, 20 years ago, these low-cost alternatives weren’t available but they are now.
Tom: Yeah. I remember about 10 years ago when I realized these mutual funds aren’t working for me and I went to the TD E-series funds. They were a great low-cost option. A little difficult to get into to get it all set up, but it’s certainly a great option that’s out there.
Larry: I think there are some better options these days, but that product is certainly much better than the TD mutual funds, for instance.
Tom: Exactly. Same bank. And there’s just a better option out there. Maybe it is the advertising and the fee benefit for them, but they really bury that option.
Larry: They don’t advertise it much. If you look at a couple of different TD products, the TD Canadian Dividend Fund—I don’t know how many billions of dollars of investor money is in that fund. But if you go to a TD bank branch, they’ll recommend that fund. That fund owns big-cap Canadian stocks. You could probably guess most of the five banks, Suncor, Trans Canada, CNR, and a couple of others. Those would be the top 10. That fund that is recommended by TD bank advisors, charges more than two percent a year. At the same time, TD bank has an index ETF fund, the TD S&P TSX Canadian Equity Fund (or whatever it’s called). It also owns the same stocks. Exactly the same stuff. I’m sure there are some differences. But essentially, it’s a similar portfolio. What does that fund charge? Less than a tenth of a percent. So two TD band products holding essentially the same stocks. One charges less than a tenth of a percent. And the other, which is the one that’s highly recommended, charges more than two percent. Actually, 25 times the cost of the index ETF which is very small. And why is it very small? Because they don’t market it. That’s sort of demonstrates the bizarre nature of the Canadian investment world where if somebody goes to seek advice from TD and the other banks is directed into the fund that costs 25 times as much as an alternative product from the same institution. Have you ever heard anything as crazy as that?
Tom: And you’re right. This applies to all banks. But the reason I singled them out a little is because of how much I do like the E-series funds that are available. The comparison is much easier to make.
Larry: Yes, not picking on TD. It’s the way the industry operates. It’s kind of like if all doctors in Canada were employed by the pharmaceutical companies and you go to your doctor and they write you a prescription for $250 for this medication. And across the street they’re selling the generic, but identical product, for $20 or something. That would be illegal. That would be against the law. But in the investment world, that’s their business model. Buyer beware. And the regulators—many good people are regulators by they’re not getting it done for the investor. They’re not making the industry be open and honest about their fees and provide proper disclosure. They’re not requiring that brokers and mutual fund sales people act in the best interests of their clients. Essentially, the regulators are—again, there’s some good people there but they’re not the investor. The average Canadian investor is very, very poorly protected by the regulators.
Tom: With the regulation, it’s self-regulated, right?
Larry: Yeah. The primary regulator for stockbrokers and for mutual fund salespeople, are what’s called self-regulatory organizations. Essentially, the government allows them to largely regulate themselves. And the boards of these regulators are populated by active industry people or former industry people. The way they operate and their rules reflect their industry orientation. Again, investors are not well protected in Canada.
Tom: Just going back for a second, when you brought up this comparison of TD funds, the idea of these regular banks with their normal funds, is that the term “closet” index fund? I wanted to cover that because I hadn’t heard that term until talking to you by email.
Larry: I mentioned earlier, most fund managers to not beat the market. Their record of picking great stocks and outperforming the market is dismal. On average, they perform equally to the market before fees. After fees, they underperform. So many fund managers recognize this. So instead of really actively trying to pick the best stocks, they just buy all the stocks in the market. They buy lots of banks and big cap like Bell, TELUS— big name American stocks. They’re claiming they’re picking hot stocks, but in reality, they’re just buying the total stock market. In other words, the index. They’re saying they’re hot stock pickers, but really they’re just buying the market. So that’s why they’re called “closet” indexers. In a way, that sort of makes sense. But when you think about it a bit more, if their performance pre fees is going to match the index, it guarantees that their performance after fees of one and a half or two percent is going to underperform the index all the time. And these are the funds like the TD fund I mentioned, that some people would call a “closet” index fund. And most of the mutual funds sold by the big banks and institutions are similar to that. They own all the big stocks. So they’re almost purpose built to underperform the market. That’s absolutely crazy when these super low cost alternatives which own the same stocks are available at a tiny, tiny fraction of the cost.
Tom: When I bought my first mutual fund, it was a Canadian dividend mutual fund.
Larry: That’s the typical Canadian fund which owns all the top Canadian stocks, which is the same as the low-cost index ETFs. Exactly.
Tom: Yeah. There’s only so many companies in Canada. By the time you buy those top 20 companies or so, you practically have the index.
Larry: Yeah, that’s right. Exactly.
Tom: So with self-regulation, one thing I liked when they regulated credit card statements was how on the statement it would tell you if you were to pay the minimum balance it would cost you so much and will be paid off 20 years from now. That really changed how people looked at these fees. Do you think we could ever get to the point where they could start doing that with investments where you’re paying this fee and it’s going to cost you this much over 30 years?
Larry: The answer to the question of could they do it is, yes. The answer to the question of will they do it is, I doubt it. The UK actually just introduced these rules. I had some dialog with the regulators in the UK around this. They did put these rules in there to disclose what the impact of fees is over a long period of time. And because that is such an enormous factor and so misunderstood by Canadians who are so unaware of it, I created this little tool on my website; larrybates.ca. Just go there and check it out. It’s called the T-Rex score. Put in some input like the fees you’re being charged, your investment time frame, and it will generate a T-Rex score which tells you how much of your returns you actually get to keep and how much are lost in fees. Again, for example, let’s say your fund is deducting two percent a year from your accounts. Throw that number in there. And let’s say your time frame is 25 years. You’ve invested $10,000. The calculator will quickly show you how much of the return you’ve retained and how much is lost in fees. And that number, by the way, would be around 50 percent using a two percent fee. A lot of people have used this calculator. A lot of people have been very surprised by the results. Every investor should understand that. And if you decide, “Okay, I’m losing whatever percent of my returns and fees but I’m getting good advice to my advisor and so on, so forth,” that’s fine. But I think many people will discover that the price they’re really paying at the end of the day is way, way out of line with the value they’re receiving given there are other products out there.
Tom: Yes, I think that calculator sounds like a great help because even if they disclose their fees for that month or year, it still doesn’t have that same impact of compounding.
Larry: And most people would think—let me give you an example. Let’s say underlying assets return 8 percent on average but you’re paying a two percent fee. Most people might say, well, “Okay, I’m losing 25 percent of my return and fees.” No, you’re not. You’re losing more than that. Over time, you’d be losing 50 percent in return because you’re not only losing the two percent every year, your return isn’t compounding at eight anymore. It’s only a company at six. So the math is extremely powerful over time. Albert Einstein said the most powerful force in the universe is compounding. Jack Vogel, who started Vanguard, the world’s largest low-cost, fund provider, had another quote. He said, “The miracle of compounding returns can be destroyed by the tyranny of compounding costs.” That’s the bit Canadians don’t get—the compounding costs which have such an enormous impact. So the calculator demonstrates a nice, simple way.
Tom: Well, I hope we’ve changed a few people’s minds here, because I think the decision you make now and what you’re going to invest in could literally be a six figure difference in your retirement.
Tom: If some people are in those mutual funds, hopefully they’ll take that next step and make the change.
Larry: It’s great you mentioned that because for many Canadians, investment fees will be their second biggest lifetime expense behind home ownership. And again, most people have no idea that that’s the case. In my book, I talk about three principles of investing. First, take a bit of time to learn the basics because your subscribers and viewers should take some time to understand investing and financial principles. Learn the basics, take a long-term outlook on investing, and minimize your costs. If you do those three things, you’re going to put yourself in a good position.
Tom: Exactly. This has been great. Can you let people know where they can find you online and also tell them about the book?
Larry: Sure, you can find me at larrybates.ca. The calculator is there. And there is a bunch of stuff there like articles and other things. So have a quick look at it. Subscribe to my newsletter. I don’t issue them that frequently—maybe once every two or three weeks. People seem to like it. My book is called Beat the Bank – The Canadian Guide to Simply Successful Investing. And again, it’s designed to be a bit of a wakeup call as to what’s going on right now, and a guide to lower costs and more successful investing. That is in stores across Canada as well as available online in print book format as well as eBook format on Amazon and other sites.
Tom: Perfect. Thanks for being on the show.
Larry: It’s been a pleasure. Thank you.
Thank you, Larry, for helping us better understand the impact of high mutual fund fees. And for showing us that there’s an easier and more affordable way to invest. You can get the show notes for this episode at maplemoney.com/larrybates. The Maple Money Show has been growing steadily and I’d love your help to spread the message even further. Can you take a minute and head over to iTunes to leave a rating and review? Plus, at the end of October, I’m giving way to copies of, I Will Teach You to Be Rich by Ramit Sethi. After leaving a review of the show, head over to maplemoney.com/review to enter your user name and date you left the review for a chance to win. And as always, thank you for listening and we’ll see you next week.