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How to increase your retirement income by 35

Richard Morin

Update :
Update :
September 11, 2017

In 2017, you'll hear a lot about the fees you pay on your investments. This interest in fees is driven by the emergence of firms like Archer that offer an alternative to the big banks - which have dominated the wealth management industry for the past 30 years or so - and by initiatives by regulators that are forcing institutions to be more transparent about fees.

It's about time we talked about fees!

Fresh Histogram

If you have $250,000 in savings, it is typically invested in mutual funds with an average "management expense ratio" of 2.3%[1]. If you are a private banking client, you pay a sliding scale fee that starts at a slightly lower rate than mutual funds. This 2.3% is deducted annually from the value of your investments to compensate your advisor and portfolio manager, as well as to pay the fund's operating and administrative costs.

In the past, investors have been dismissive of fees, either because they don't know how much they are paying (it seems that most investors do) or because they see them as a necessary evil.

The impact of fees on savings and your retirement

Fees have a corrosive effect on your portfolio. If you earn a gross annual return of 6% and pay a 2% fee, that's 1/3 of your return going to fees. Even worse, with the compounding effect, fees can eat up half of your long-term return and make a difference of hundreds of thousands of dollars when you retire. This drain on your capital can delay your retirement by several years.

Long-term impact graph

The table above illustrates the impact of fees for an investor with a starting capital of $250,000 who maximizes his RRSP contribution for 25 years. The difference after 25 years is over $300,000.

Even worse, the effect will continue to be felt after retirement as the fees will continue to eat into the income generated by the savings. For example, when you combine the impact on the capital at retirement ($400,000) and the return on those savings over 30 years of retirement, a 1% reduction in fees can increase retirement income by almost 35%[2]!

How to reduce your costs?

Of the 3 components of fees, those related to portfolio management are the easiest to reduce. In fact, since the average mutual fund underperforms the market indexes, by replacing your mutual funds with exchange-traded funds (ETFs), you could reduce your fees, and therefore increase your return, by about 0.75% per year.

It is also less expensive to operate and administer an ETF portfolio. Finally, an advisor who uses ETFs and advanced technology to structure your portfolio will realize productivity gains that translate into lower fees (for a higher level of service).

In total, you could reduce your fees by 1.0% ($2,500 per year for a portfolio of $250,000), allow your savings to grow even faster and ensure a richer retirement.

1 ] Source: Vanguard Canada

2 ] Starting portfolio of $250,000, annual contribution of $25,000 for 25 years and disbursement for 30 years at retirement. Gross annual return of 6%, fees of 2.3% for mutual funds and 1.3% for Archer.