Options are limited for young investors or those just starting to save for retirement –but the latest industry offering could provide an inexpensive way to diversify a small portfolio and get professional advice.
For most investors, mutual funds are the way to fill that dual role but fees can chew up a big chunk of those savings, not to mention future returns. Mutual fund investors will get a better idea of just how much those fees are when advisors are required to reveal them in dollars as well as percentages over the next year.
What’s the big deal?
Mutual fund fees aren’t getting lower. They are just being expressed to investors in a different way. The investment industry has been dragging its heels on the requirement to disclose fees in dollars because it knows a fee expressed as a percent is much easier for a customer to digest than a dollar amount.
Here’s what I mean: a typical annual fee paid to the advisor who sells a mutual fund, also known as a trailer fee, is one per cent. One per cent doesn’t seem like a lot but when you break it down to a fee on a $100,000 portfolio, that’s a charge of $1,000 every year – whether the funds make money or not. That’s $1,000 out of your savings today and $1,000 each year that won’t be allowed to grow.
Surveys show most mutual fund investors don’t even know about the one per cent trailer fee because it is hidden in another fee called the management expense ratio. The typical 2.5 per cent annual MER is not required to be disclosed in dollars under the new rules, but it amounts to $2,500 on a portfolio of mutual funds totaling $100,000
What’s the alternative?
There are not many alternatives to mutual funds for small investors who want diversification and professional management. Most of the big-shot portfolio managers you see on BNN charge a smaller, flat fee of one per cent or one-and-a-half per cent. One per cent on smaller portfolios isn’t really worth portfolio managers’ time unless they take on several clients, which leaves less attention for individuals. Several won’t even consider taking on a client with less than $500,000 to invest.
Small investors have the option to go it alone and invest directly in the market but it’s hard to diversify with small amounts of money. Having all your eggs in a few baskets increases risk and picking the right baskets is incredibly difficult.
Many investors get diversification through exchange-traded funds, or ETFs, which buy entire indices like the S&P 500. However, there is no professional manager to tell you which indices to buy or when to buy and sell.
How robo-advisors can help
So-called robo-advisors have been popping up on the Internet. There are just over ten major services and big banks like BMO are joining in. Services vary and are evolving, but here are the basics:
- Investors fill out a questionnaire that gathers information about their investment goals, when they want to retire and their tolerance for risk.
- The computer system analyses the information and recommends a model portfolio of exchange-traded funds. ETFs are the initial investments offered, but more products may be available as the service develops.
- Customer support is provided through live chat, email and telephone.
- But it’s the fees that give robo-advisors the greatest appeal. They vary from service to service and often decrease as your savings grow, but are usually less than half of a per cent of assets invested each year. Some offer a flat monthly price.
On the downside, robo-advisors don’t give you the personal connection of flesh-and-blood advisors who come to know their clients over the years. It might be wise to consider a robo-advisor a temporary measure until you can build your savings, and then get yourself one of those big-shot portfolio managers on BNN.