By Warren Mackenzie on October 18, 2013
Every investor needs to understand how easy it is to ensure that his or her portfolio performs at least as well as the market does. Here is the reason why. Over the next decade, many experts would agree that a balanced portfolio could be expected to yield between 4% and 6% before investment management fees, income tax and loss of purchasing power due to inflation.
Let’s assume that the portfolio return is 5% and investment fees are 1.5%, the tax bite will be about 20% (assume the portfolio is not an RRSP portfolio) and that inflation is running at 1.5%. After deducting fees, tax and inflation, we would be left with a bit over 1%. Here’s the math: 5%–1.5% (fees)=3.5%–0.7% (income tax on that rate of return)=2.8%– 1.5% (inflation)=1.3% net.
This is not a large return and if your portfolio is also underperforming the market by 1% or 2% (very common), then you are at best making nothing – or maybe you are losing a small percentage.
Most people cannot afford to make nothing on their portfolio, but fortunately, it is easy to ensure that your portfolio performs at least as well as the market does. You can do this by purchasing Exchange Traded Funds.
If you were invested in the same asset mix as above, but were using ETFs, your return in this example would be about 1% higher because the investment management fee (called the MER) is lower (0.3% versus 1.5%) and you don’t have to worry about underperforming the market by 1% or 2%, because ETFs are the market.
Most investors are reluctant to start managing their money themselves, because they think it is a complicated process and that they need extensive knowledge about investments. Fortunately, this is not the case.
Here is a simple way to prove this to yourself. Go to your bank and open a self-directed tax-free savings account (TSFA), or use an existing TSFA, and buy a few ETFs. If you don’t know anything about ETFs, no problem. Choose a model from among those constructed by the Canadian Couch Potato Blog. It doesn’t matter which one you choose, because you will invest only a small amount of money and you are doing this to learn a new skill.
When you choose your model, you will know which ETFs to buy. You can even get help from your online broker to walk you through the steps to complete your purchase.
After you’ve made your purchase, forget about it for one to three years. Then go to ShowMeTheReturn.ca and use this tool to calculate your return for the period. Use the same tool to calculate the return on your ‘advisor-managed’ portfolio. Then go to this calculator on our website and compare your performance to your benchmark, and compare your advisor’s performance to his or her benchmark.
If the advisor has done as well as you have done, be generous with your referrals. If you have done better than your advisor (and I expect you will have), then ask yourself why you are paying high fees to underperform.