Investing Series: What to look out for when you’re investing (fees and other tactics)
This is a part of the Investing Series.
This is by no means a comprehensive list of shady tactics that financial advisors will pull on you, but it’s the ones I’ve come across, and are fairly common and easy things to check.
If you have any more tips you’d like to pass on to new investors, please make note of them in the comments and I shall update the post accordingly.
BE SUSPICIOUS OF ANYONE WHO SAYS THEY CAN MAKE IT RAIN
Every banker or advisor I’ve ever come across has tried to get their paws on my money by making commissions off selling me overpriced mutual funds.
Fat Joe & Lil’Wayne Makin’ it Rain (via MTV)
Another trick is to sell you life insurance.
As long-time reader tomatoketchup pointed out in the comments in this post: What is investing, exactly?, there are a lot of crooks out there who make their fortunes by screwing you:
One important thing to mention is to be very cautious around anyone that calls themselves a Financial Advisor or Financial Planner (including companies like Edward Jones and Ameriprise for people living in the US).
These people are almost always scavengers out to take a cut of your money while providing absolutely nothing useful to your finances.
I had a “financial planner” who in hindsight was really just an insurance salesman, and fortunately I discovered sooner rather than later that he was managing my money with his interests in mind; not mine.
He got too greedy which set off a red flag and inspired me to learn about this topic. After I fired his ass, I manage all my investments on my own which consist of only 3 index funds.
A very easy litmus test to identify these jackals: anyone who tries to sell you any type of permanent life insurance (e.g. whole life, variable universal life) is trying to take your cash.
All I can say is to be suspicious because lot of people want a bit (or a lot) of your money for themselves.
If it was as easy to make money as they say it is, bankers wouldn’t be feasting like kings off all those the fees they charge us to manage funds, because they’d be millionaires and wouldn’t really need to work.
Be suspicious of financial advisors like Charles in this hilarious video:
THINGS YOU MIGHT COME ACROSS AS PRESSURE TACTICS
It usually starts like this (with my experience):
Are you actually happy with those returns?
Because we have a great line of actively managed funds that I could show you…
Or how about this oldie but a goodie?
Do you even know anything about the stock market and investing?
I mean, what’s your education and credentials in being able to manage your money on your own? Do you have any knowledge or FINANCE-related accreditation?
At this point, I stop them, and can respond in three ways:
- Very Nicely
- Outright Rude
#1 Very Nicely: Yes, I’m happy with those returns. Thank you. 😀
#2 Snarkily: Oh really? Tell me, do you invest all of your money in those funds?
#3 Outright Rude: You don’t say! Listen, I’d love to give you all my money to help me invest it, but first — can you tell me what your personal net worth is right now and how much you have personally made with these funds you’re trying to get me to buy?
I tend to choose Response #1 most of the time, unless they annoy me, in which I move on to Response #2.
I’ve never had to use Response #3, thankfully, but I’ve come close, especially when they try to put me down and make me feel stupid because they think that women don’t know anything about investing and don’t have the brains to learn it on their own.
I’m sure they get a lot of money intimidating people that way, by flashing their “financial credentials” around to bully people into indirectly paying for their year-end bonus.
Now I know this might seem unorthodox and rude to toy with financial advisors especially since it’s their job to make money off you, but it frustrates me to no end that investors are basically letting their hard-earned cash that they’ve saved, just slip through their fingers because they think someone else who calls themselves a “financial advisor” knows better than they do.
Do some research, and become a “sophisticated” investor so that you don’t fall for their tricks, and you are able to evaluate what they’re saying to you to see if it holds any water.
You don’t have to be mean the way I am, but you’ll notice just how fast they back off if they reach Response #2, because NO ONE wants to talk about their finances or lack thereof.
MANAGEMENT EXPENSE RATIOS (MERs)
Management Expense Ratios are a fancy way of saying that investors need to pay for the guy that they’ve hired to manage the mutual fund that you’re investing in, plus other fees (keep reading).
This hired financially-sound person will watch the portfolio and make sure that it follows what it says it was supposed to do as its strategy among other things.
WHAT MAKES UP AN MER?
- Management expenses: Investment research, marketing, the bank’s profit
- Dealer/Advisor Compensation or Trailer Fees
- Administrative Costs: Regulatory expenses, service costs, legal and audit fees
- GST (Canada): Goods and Services Tax
If you want to know exactly HOW much they take out of your account, it’s a bit tricker because it is taken out as a percentage of the entire portfolio of assets held at the bank in that mutual fund, not based on your money specifically.
This is what it looks like as a pie chart:
You can read a lot more about MERs here.
WHERE DO I FIND AN MER?
To find this “MER”, look around on the page that deals with that fund, and look for the part where it talks about fees; here’s an example:
HOW DO THEY TAKE OUT THE MER?
0.35% means that they take 0.35% of the entire assets of the portfolio, or out of the $422.78 million as of December 31st 2012, which obviously can change as assets will increase or decrease as the year goes on.
These calculations below are just a demonstration of how it works in general:
0.35% x $422.78 million = $1,479,730 a year, or $4054.05 a day
You only pay a portion of that $1.479 million a year, based on how many units you own.
With TD Canada Trust in particular, they take the MER out on a daily basis.
This amount will change as the funds assets grow and shrink, so I am fairly sure it isn’t based on just a single December 31 2012 number in this case.
If there’s more in assets by January 1st 2013, they will take the same amount of MER (that is the same percentage) out, just out of a bigger pot of money, which will end up as more than the $4054.05 a day.
This is calculated on a daily basis, which means the fee that you pay will also change on a daily basis.
Now do you see why everyone harps on MERs and making sure you don’t over pay?
In this particular example, let’s say you own $10,000 in this particular fund that charges 0.35% as an MER because it’s passively managed.
As I understood it, it works like this (Investors, please correct me if I’m wrong):
$10,000 / $422.78 million = 0.0024% is what you own of the entire fund’s assets.
0.0024% x $4054.05 = ~$0.10 a day
In contrast, if your actively-managed fund charged a 2.3% MER with the same assets of $422.78 million, this is what it looks like:
0.0024% x $27,220.08* = ~$0.65 a day
Yep. $0.54 extra in fees being eaten every single day you invest with them.
*Got this number of $27,220.08 by taking 2.3% x $422.78 million, and then dividing it by 365 days of the year.
BUT DON’T I MAKE MORE MONEY WITH HIGHER MANAGEMENT FEES?
You’d like to think so.
A question I asked myself at the start of all this investing was: Do these actively-managed funds actually return MORE versus passively-managed funds over the course of your investments?
The answer I got was: No. Studies have shown the contrary, which I will go more in-depth about in my Investing Series.
Over a life time, it really adds up, especially if you continue adding more and more money, and taking into account that inflation that also eats away at your future purchasing power each year.
The difference becomes even greater if you think about having $100,000 in the pot:
$100,000 = 0.024% of the fund’s total assets
0.024% @ 0.35% MER = $0.96 cents a day
0.024% @ 2.3% MER = $6.44 a day
We’re dealing in the DOLLARS now, not just in pennies of a difference in cost.
Update: Hat tip to Jared for catching my wonky late-night calculation and typos. You miss ONE space or a dot at 9 p.m. in a post and it screws everything O_o
WHAT IS A GENERAL RULE FOR THE COST OF A MUTUAL FUND?
There’s no rule, it depends on what the bank wants to charge.
If you want a benchmark for index-tracking mutual funds (a.k.a. Index Funds), I’d say around 0.50% and lower is “normal”, but you can find them as low as 0.15%, even in Canada.
Other actively managed funds start at 1% and go up to 2.5% or even 3% at times as an MER.
WHAT ARE ‘NO LOAD’ MUTUAL FUNDS?
Everyone talks about buying “no load” funds, but WTF does that mean?
No load means they don’t charge you to buy the funds.
I know, at this point you’re thinking:
But .. I’m GIVING my money to them.
They’re taking MY money to invest, and they still want to charge me money on top of that!?
This is where banks ALSO make their money in addition to MERs, by charging you a friendly 5% sales commission on selling you a fund that you so desperately need to buy.
ACCOUNT FEES THAT ARE BELOW MINIMUMS
This is not a huge deal, but generally if you have less than $10,000, they will charge you an account fee because you don’t have enough invested with them.
Much like not having $1000 or $2000 as a minimum balance in your chequing account, you can get slapped with a small fee each year for having an account that doesn’t meet the minimum balance required.
This should in NO WAY deter you from starting to invest, because the fee isn’t a massive amount of money, and you should just get started and work towards waiving those account fees.
This is why it’s a great idea to stick to one bank or brokerage, and do all your buying with them.
MOVING RETIREMENT ACCOUNTS FROM ONE AREA TO ANOTHER
You can move your retirement accounts from one bank or brokerage to another, but BE CAREFUL and call ahead of time to make sure you aren’t making a mistake.
For instance, if you take out the money from your retirement account (RRSP, 401K, IRA, TFSA) with the good intention of putting it back into the same retirement account but with a DIFFERENT bank, call both banks ahead of time for the procedure.
You don’t necessarily have to even lift a finger and get the money in a cheque made out to you, you can just ask for a direct transfer and let the banks deal with it.
CANADIAN RRSP FROM ONE BANK TO ANOTHER
A good real-life example is when I left my company. I had a retirement plan with them that I was NOT planning on keeping because their mutual fund selection had no index funds, and they were charging me a fixed account service fee to boot.
I called my bank and told them I wanted to move my RRSPs and they set everything up without my having to receive a cheque or have any money pass through my hands.
This is especially important that come tax time, you don’t LOOK like you’re trying to raid your retirement accounts on the sly, because the government will penalize and tax you on such withdrawals.
THERE’S ONLY ONE TRICK I KNOW OF, FOR TFSAs IN CANADA
Let’s say you put all your TFSA money into one bank or one area. As TFSAs are tax-sheltered and not tax-deferred, you have already paid tax on that money, and it’s allowed to grow without any additional taxation.
If you want to move it all to another bank, you could wait until December, and simply withdraw all the money before the end of December 31st, and then re-deposit it in the new bank in the new year let’s say January 1st when the TFSA contribution room resets itself.
I still don’t like this for anything except straight-up savings accounts, because a lot of things can go wrong, but it’s something you can consider if you are thinking of moving TFSA savings accounts from one area to another.
AMERICAN 401K FROM ONE BANK TO ANOTHER
Another example I have is for Americans this time, is let’s say you want to move your 401K or IRA from one bank to another.
You have to ask and specifically get the details for a trustee-to-trustee transfer so that come tax time, your 1099-R doesn’t have any sort of code (other than Code: G) that says you withdrew the money completely and now owe federal and state income taxes on, and an additional 10% penalty on the cash (for anyone under 59 1/2 years old).
Let’s not even mention the fact that if you shift your accounts in the U.S., the original bank could very well do a friendly 20% withholding tax on your accounts to “prepay” the taxes you may owe, in case you decide to keep the money rather than put it in another retirement account.
You’d lose 20% right off the bat, plus other fees I am sure I haven’t heard of yet, and you can recoup that 20% when tax time comes around, but you’ve basically handed over 20% of your retirement account to the government for them to use for free, no interest being earned or accumulated.
It’s just as silly as getting a tax refund.
ALWAYS CHECK WITH YOUR BANK BEFORE MOVING RETIREMENT ACCOUNTS
I’d give an Australian or U.K. example at this point, but I haven’t lived or worked there, so I’d be useless. Please call your bank before you move your Superannuations or Pensions (if you’re even allowed to..)
IN GENERAL, MOVING ACCOUNTS IS A BAD IDEA
I really, strongly suggest you do your research and stick to ONE bank, ONE brokerage and ONE area to do your investing in.
You can get the most amount of gains out of sticking in one place and not shifting all the time, even if you can chase down higher interest rates.
Even if you can avoid being flagged by the Canada Revenue Agency (CRA) or the Internal Revenue Service (IRS) for dipping your paws in your retirement cookie jar, you may also incur costs to do these transfers.
Some banks don’t want you to leave them (rightly so), and they could very well impose an administrative charge to move one account from one bank to another to deter you from leaving their bank.
- Be suspicious of financial advisors; everyone is out for some of your money
- You can learn enough to be a “sophisticated” investor and cut out the middlemen
- Follow your instinct and stay stubborn to the investing strategy you’ve chosen
- Watch out for Management Expense Ratios (MERs) that eat a chunk a day
- No Load mutual funds are mutual funds that don’t charge a sales commission
- Be aware of how much you need as an account minimum to waive their fees
- Stick to one bank and/or brokerage for investing; don’t spread your money around
- Don’t move around too much if you can help it, it may cost you a lot in fees & taxes