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For example, suppose an initial $10,000 investment
returns 9 per cent per year before fees. According to the light grey column
on the chart, after 40 years it would be worth about $314,000. If that
return is then reduced to 7 per cent to account for a 2 per cent fee - about
the median management expense ratio for most mutual funds in Canada – the
ending portfolio value then becomes worth only $150,000. The unnoticed 2 per
cent in fees has resulted in a loss of $164,000 in value.
No matter
what time period or rate of return is chosen, the effect of avoidable costs
is staggering. And remember, these results are based on a one-time
investment of only $10,000 with no further contributions.
Saving $164,000 over 40 years averages out to $4,100 per year on each
$10,000 invested. If you could spend two hours once a year administering
your own portfolio to save those avoidable costs while outperforming a
majority of actively managed mutual funds; would it not be worth your time?
There is an investment strategy that accomplishes these objectives but is
not widely promoted. It is not in most institutions' interest to design a
portfolio for an ordinary investor that relies on the lowest cost investment
products, minimal turnover and patience.
Study after
study on the performance of low cost index based funds show that they
repeatedly outperform the majority of higher cost actively managed ones. The
annual savings in fees of 2 per cent in favour of index funds is just too
high a hurdle to surpass year after year. This should not really be
surprising because outperformance is a zero-sum game before costs. Some
active investors may outperform the market, but it means that others have to
underperform.
Even over five years, low cost index based funds have two indomitable advantages.
They start off with a cost advantage and since they represent the market, an
investor is assured of not underperforming it.
Sounds intriguing, don’t you think? The next section describes the products
and services that allow you to take control of your investments, thereby
transferring their management to the only person who really cares about your
money – you.
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