Isn’t it amazing how so many people can “know” something intuitively, yet simultaneously not “know” it in practice? Take the old adage “a penny saved is a penny earned.” My guess is that if you asked everyone in your smartphone contacts list if they know what it means, they’d say yes—but at the same time are paying their advisors more than they should for financial advice. On the flip side, how many financial planners do you suppose take product cost into account when doing retirement projections for their clients? In my experience, the answer is: nearly none.
The lesson here is simple. If you honestly believe that a penny saved is a penny earned, then surely the way to earn more money is to pay less money.
This little bit of self-evident logic seems to be lost on many advisors, who continue to recommend unnecessarily high-cost investment products to their clients.
Certified Financial Planners (CFPs) across Canada have been given a set of guidelines by their national certification body, FP Canada. These guidelines are recommended factor inputs for financial independence projections. The return assumptions are about 7% for equities (such as stocks) and around 3% for income-bearing products (such as bonds). Exact numbers vary based on the type of equity and income. If presented properly, these numbers also include the recommended best practice of lowering return expectations by the amount of costs incurred. This is a critical wrinkle that, in my experience, almost every single planner in the country is overlooking. Given that the combined cost of both products and advice is often between 1% and 2.5%, the impact on a client’s actual return is likely to be enormous.
A portfolio that is half stocks and half bonds might have en expected return of 5% before costs, but if that portfolio had an average cost (products plus advice) of 2%, it would be appropriate to plan for a return of only 3% (5% in expected returns minus 2% in certain costs).
Using model portfolios that increase the equity exposure in 10% increments and starting at a 50% equity, 50% income portfolio, we get six model portfolios ranging in their expected return from 5% (50/50) to 7% (100% equity/ 0% income). Here’s where it gets interesting. The difference between low cost products and high cost products is usually between 0.5% and 1.0% and the difference between no advice and expensive advice can be up to 1.5%. This is shown in the chart below:
|Equity/Income Asset Mix||Expected Return||Expected Return at 1% Cost||Expected Return at 2% Cost|
Let’s take a moment to consider that you can expect to get the same return on a balanced 50/50 portfolio as you would on a risky all-equities 100/0 portfolio that costs 2% more. If that doesn’t terrify you, I think it should.
Clearly, the more money you save in costs; the better your overall return, assuming everything else is the same. So why do planners continue to put their clients’ money into higher-priced products?
In terms of your expected long-term return, lowering your product cost by 0.8% is the same as increasing your equity exposure by 20%. Simply put, lower costs equal higher expected returns. The real beauty is that the substitution to use low cost products in the place of more expensive products is that the risk profile is unchanged. In other words, one could increase expected return by 0.8% by moving from a 60% stock/40% income portfolio to an 80%/20% mix or by substituting high-cost products out and low-cost products in, and pocketing the 0.8% difference. Both get you retired at about the same time, but only the low-cost substitution option does so without increasing your risk.
It used to be said that in planning for retirement, there were only four variables that could be manipulated to reach a goal. They were:
- save more (easier said than done);
- invest more aggressively (not recommended and often not even allowed for advisors);
- retire later (which I have long felt is the most sensible option – especially given increased life expectancy); and
- accept a lower standard of living in retirement (the default option if you fail at the first three).
I believe financial planners can safely add a fifth option to their retirement projection toolkit—one that is easy to understand and easy to implement—for the sake of investors. That fifth option is simple: lower your costs.
John J. De Goey, CIM, CFP, FELLOW OF FPSC (the author) is a portfolio manager with Wellington-Altus Private Wealth Inc. (WAPW). The opinions expressed herein are those of the author alone and do not necessarily reflect those of WAPW. No financial decisions should be made solely on the basis of the information and opinions contained herein. The information and opinions contained herein are subject to change without notice. John’s advisory website is standupadvisors.ca. John’s writing website is standup.today