It’s now 2020. I turned 50 a few weeks ago, and I like to think that in that half-century, I have seen a few things. The biggest surprise for me is arriving at this year and seeing that the world looks nothing like I was told it would be as a kid growing up in the eighties and nineties. No flying cars. No interplanetary travel. No post-apocalyptic battlefields fraught with firefights featuring lasers and photon torpedoes. The teenager in me is a bit disappointed, really.
However, the biggest disappointment has been in the development (or lack thereof) of the Canadian financial-services space. Despite rapid technological advancement, the business of banking and investing in Canada is largely unchanged since at least the 1990’s. In fact, many banks still run on software from that era, even now. When I left banking in 2017, a few banks still had platforms running on MS-DOS!
Clearly, there is huge, and largely untapped, potential to leverage technology and do better.
If you are a Canadian investor, the time has long since past where you should be considering the banks’ investment offering as adequate, let alone desirable. I am going to tell you why, and then I am going to tell you what you can do about it.
The Banks’ Investment Offering
When you walk into a Canadian bank, and tell them you want to invest, you will be directed to one of two people: either an “advisor” if you don’t have a lot of money to give them, or a “planner” if you do. The difference is that a “planner” is tasked with offering you some type of financial plan before attempting to secure your investment dollars. However, once that is out of the way, the process is exactly the same regardless of who you are talking to.
What the bank employee will do is ask a series of questions designed to determine your investment objectives and your tolerance for risk. The responses are entered into a computer program that will then determine an appropriate asset mix for you, and recommend a few mutual fund portfolios (all of which are pretty similar to each other) that are aligned to that asset mix. As a hedge against complaints and litigation, the employee is almost always required, by bank policy, to sell you one of the recommended portfolios assigned to you by the software. Creativity is actively discouraged.
Your new investment will likely come with total fees that average from 1.5% to 2.75% per year, based on your investment balances. A part of that, typically 1%, is a “trailing commission” paid to the bank from their mutual fund arm which covers the “services and/or advice that your representative and/or their firm provide to you”. That quote is taken directly from one such firm’s disclosure material.
Is This Really The Best Way To Spend Your Money?
So let’s stop and think about this. If you have a modest portfolio of, say, $60,000. Your bank is going to ask up to $1,650 per year ($137.50 per month) from you to hold and manage that investment on your behalf. Of that amount, $600 ($50 per month) is paid because the bank advisor completed the online questionnaire for you and sold you the recommended product. That was their “advice”.
$50 a month, every month, for as long as you are invested. All for completing a 10-20 question assessment with you. And they’ll likely not do anything for you after that, because they know, as we know, that the only way to invest successfully is to hold for the long-term.
If your bank had clearly outlined this value proposition when you walked in, would you have agreed to it? Probably not. But because these fees are hidden inside your mutual fund account, and masked by the ups and downs of your portfolio returns, it feels “free”. And so year after year, millions of Canadians let the banks take lots of their money, and give very little in return.
Not convinced? Spend a little time playing with Larry Bates’ excellent investment fee calculator and see for yourself.
You Can Do This Yourself – Stop Overpaying Someone To Do It For You
If someone offered to wash your car for you, just once, and in return wanted $50 a month from you in perpetuity, would you accept the offer? Of course not! No matter how much you hate washing your car, you’d either do it yourself, or find someone willing to do it for a one-time price that was better aligned with the service provided.
In reality, thanks at least in part to technology and innovation on the part of non-bank firms, investing is now easier than ever. In fact, it’s almost as easy as washing your car, and anyone can do it.
By doing a little work yourself, and investing in low-cost, ETF-based portfolio funds, you can lower your investment costs by 90% or more. So here is The Money Geek’s super-simple plan for investing your money and telling the banks to take a hike!
Step 1: Determine The Appropriate Account(s) and Savings Rate
RRSP, TFSA, RESP, Non-Registered…..how to know which account is right for you? There are plenty of online articles on this topic if you want to make the determination on your own. Google is your friend. For long-term investing, most will focus on tax-advantaged accounts (RRSP/TFSA) for the tax benefits, until they have no more contribution room, or their retirement plans make them no longer practical (this usually only applies to those with very large portfolios and pensions).
As for savings rates, most people will be well served with the advice to save “as much as you can, as fast as you can”. The fact of it is, the vast majority of Canadians have wildly underfunded retirement accounts and inadequate emergency savings. Simply doing what they can, when they can, will be a big step forward for many, if not most.
If you need more specific advice, or don’t want to make these decisions alone, a competent accountant or fee-only financial planner can help. Pay them once to look at your situation and recommend both the best account structure for you, as well as the amount you’ll need to save each month or year to meet your retirement goals. The one-time cost may seem onerous, but it’s a lot better than paying an ongoing amount for life.
Step 2: Determine Your Appropriate Asset Mix
The biggest factor that determines both your investment risk, as well as your potential for returns, is the ratio at which you hold bonds versus stocks. Bonds generate lower returns, while having generally more stable values, while stocks tend to generate higher returns, but the values go up and down to a greater degree (in other words, stocks are “riskier”).
As discussed earlier, a bank employee determines your asset mix by plugging your answers to a series of questions into a computer program. Fortunately, you can do the exact same thing yourself, in just a few minutes, and for free! The recommendation that is produced will tell you the bond/stock mix that is appropriate for you and your situation.
A great asset allocation questionnaire can be found on Vanguard’s Canadian investing site. When completed, the result will look something like this:
A note on asset-allocation questionnaires: as you are answering the questions, remember that your anticipated rate of return and the risk you take on (the rate at which the value of your portfolio goes up and down over time) are linked. There is no such thing as a low-risk, high-return portfolio.
Also, “risk” does not mean there is a likelihood that you will lose all your money. If you invest in a well-diversified, index-linked portfolio, there will likely be hundreds (if not thousands) of different stocks and bonds from around the world that you will be invested in. The only way to go to $0 would be for every one of those companies to fail. If something like that ever did happen, even your bank-based savings account wouldn’t be safe.
Step 3: Open A Discount Brokerage Account
In order to get the benefits of very low-cost investing, you’ll need to open a self-directed investment account with a discount broker. This allows you to purchase investments on your own, without having to pay excessive brokerage fees or ongoing commissions. In most cases, there will be a small fee to buy and sell, plus the underlying fees on whatever investment you choose.
The appropriate accounts (RRSP, TFSA, etc.) can usually be opened online without a great deal of effort. Existing assets can then be transferred from your current institution. Although self-serve in nature, any discount brokerage will provide phone support for opening an account and transferring funds, if needed.
If transferring existing investments from a bank or other investment company, be sure to confirm with them if there will be any fees for transferring out before proceeding. In many cases, these fees will be refunded by the institution your investments are being transferred to.
Personally, I use Questrade (affiliate link). The platform is excellent and I can purchase Exchange Traded Funds (ETFs) without commission, in most cases. However, all the big banks have similar services, and there are several other independent firms, as well. Whichever service you choose, be sure you understand the costs by reading their fee schedule, which is usually pretty straightforward.
Step 4: Purchase Your New Investment
Once your self-directed account is open, and there is money in it, it’s time to purchase your investment. To keep it simple, what you want is a “portfolio ETF”, also known as an “asset allocation ETF”. These are funds that are designed to be properly allocated, widely-diversified holdings, that are regularly re-balanced to their target weightings. Roughly the same type of investment you’d get from your bank, or most investment advisors, but without the high costs.
Having used the Vanguard asset allocation questionnaire, I don’t see any reason why I wouldn’t invest in a suitable Vanguard portfolio. As can be expected, Vanguard offers portfolios that are nicely aligned to their asset allocation questionnaire models.
Here’s the portfolio that would be suitable for the questionnaire result above:
And here are the underlying holdings. Note the nice mix of domestic, as well as international assets:
Significantly, the current management expense ratio (MER – the fees charged to operate the fund) on this investment is a paltry 0.25%. Compare that to what a bank or other investment firm would charge on a similar mutual fund investment: up to 2.5%. On a $60,000 investment, your costs will amount to $150 per year, versus up to $1,500. A potential savings, on average, of $112.50 per month!
Could you use an extra $112.50 in your investment account every month? I bet you could. And so could I. So why would you choose to pay that money to your financial institution instead?
Please note: while I am using Vanguard for this example, it’s only because they have a useful site, and quality investment products. I receive no compensation from Vanguard, and none of the links I have included to their site are affiliate links. This is not a recommendation for you. Do your research and make decisions appropriate for your circumstances.
Step 5: Hold Your Investment Forever (Approximately)
It seems like a tired old saw, but time and again, studies have shown that the only investment strategy that works consistently is a “buy-and-hold” strategy. Since a portfolio fund (like VBAL) is regularly re-balanced to its target weightings, there isn’t much that you really have to do.
Every couple of years you should revisit the asset allocation questionnaire to ensure the investment is still a fit for your current circumstances and risk tolerance. Outside of that, add funds regularly, according to your savings strategy, and watch it grow.
Things You Need To Know
1) Lower Cost Doesn’t Mean Lower Performance
In fact, just the opposite is true. A 2010 report by Morningstar had this to say about the relationship between fees and investment fund performance:
“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.”
“Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”
2) Portfolio ETFs Aren’t For Beginners Only
Because these investments are simple and cheap, a few people write them off as being for beginners, and something you want to abandon as your wealth grows. This is totally not true.
It is true that these investments are not perfect. There are strategies you could undertake that could squeeze out some extra returns here and there. But these gains are at the extreme margins. Study after study has shown that if you choose an appropriate asset allocation for your circumstances, and stay invested regardless of what the markets do, you will achieve the vast majority of the returns that are possible for you to achieve. This is why banks and investment companies largely follow this very same methodology. It works. No matter how much you have invested, or for how long.
3) This May Not Be Right For People Starting From $0
Some discount brokerages have account minimums that have to be met, usually $5,000, but sometimes less. Also, making regular and automatic monthly contributions to an investment isn’t as easy as it is at the bank. If this is your situation, start investing at the bank, but transfer out as your balances grow.
4) Getting Set Up Will Require Some Time and Effort
One of the reasons people go to the bank to invest is that they want to sit there while someone else does all the work for them. That won’t happen here.
Once set up, ongoing investing in a self-directed account takes very little time. But getting going will require some time and effort with forms and websites, and some postage as well. If you have a few accounts, and some transfers to look after, you will be looking at a few hours of work. But that few hours will save you a lifetime of significant and unnecessary expense. It’s completely worth it.
Need Help? I’m Here For You
If this is something you really want to do, but the task seems overwhelming, reach out to me. For a very, very modest fee to cover my time, I’ll review your current holdings, point out any challenges to moving to self-directed accounts, fill out the transfer forms and complete the account opening documents with you. As a bank employee I did this for hundreds of clients, and I have no problem doing it for you, too.
I can also help with determining a reasonable savings rate and suggesting which types of accounts you should be investing in.
What I can’t do is recommend an investment for you. I can point you in the right direction for tools that can help, but that decision is yours alone, as is the ongoing maintenance of the account once set up.
It’s Up To You, Canada
It never ceases to impress me the extent to which Canadians complain about the banks. As a former bank employee, I heard it constantly. Even more than I heard grumbling about cold winters.
And yet, these very same Canadians have also shown an impressive unwillingness to change. They doggedly stick to their bank advisor and bank investments, even when they know they are getting hosed on fees. And those fees are resulting in lower levels of personal wealth, and poorer retirement outcomes. This is one of the reasons why mutual fund fees are so much higher in Canada than in the U.S.: Canadians are simply willing to pay them. It’s sad, but true.
So if you have ever thought about trying self-directed investing, or you are tired of paying fees for little-to-no service, the time has never been better to make a switch. There are more high-quality options than ever, and more people willing to help. All you have to do is ask.
Important Disclaimer: This page may contain affiliate links to products. We may receive a commission for purchases made through these links. These commissions do not generate a cost to the user and do not impact any product reviews as we try to be as objective and fair as possible regardless of affiliate program status.
The information above is for general informational purposes only and does not in any way constitute an offer for the purchase or sale of any security and is not intended to be considered comprehensive or personalized financial or investment advice. themoneygeek.info assumes no responsibility for the use or application of this information. Always consult a tax, investment, or other appropriate professional before adopting any new financial strategies.
I am an accredited Financial Planner with 23 years of experience in the financial services industry. During the course of my career I completed hundreds of financial plans and recommended and sold hundreds of millions of dollars of investment products. I believe that financial independence is a goal anyone can aspire to and I am passionate about helping others to live life on their own terms.