A fee war is driving online brokerage commissions to zero in the United States, a spectacle that is going to divert investor attention from more pressing matters.
Competition to lower fees is never a bad thing in the investing industry, but it sometimes amounts to a sideshow. Brokerage commissions are an example – even at the rates charged to Canadian investors (as much as $9.99 per buy or sell), they’re not a top concern for people investing for the long term as opposed to short-term speculation.
By all means, check out brokers with low commissions. In Canada, this group includes CIBC Investor’s Edge, HSBC InvestDirect, Interactive Brokers, Questrade and Virtual Brokers, all with markedly lower costs than the big bank-owned firms that dominate the sector. On Oct. 15, National Bank Direct Brokerage will introduce a new pricing plan offering young investors (aged 18 to 30) 10 free trades a year plus additional trades at $4.95, and $6.95 trades for National Bank clients with a bank account connected to the NBDB platform. Others pay the usual $9.95 flat.
Don’t focus your search for low costs on commissions alone, though. There are five other costs that do more damage to the portfolios of do-it-yourself investors:
1. Foreign exchange fees
Forex is a profit centre for online brokers. Investors add Canadian dollars to their account and have it converted by their broker into U.S. currency to buy U.S.-listed stocks and exchange-traded funds. For that service, brokers will mark up the wholesale rate paid by the largest institutions to build in a tidy profit margin.
In my latest online brokerage ranking, I asked firms to provide the cost of an investment in U.S. shares on a particular day. The markup over the rate published by the Bank of Canada can be as much as 1.5 per cent.
What to do: Use TSX-listed ETFs for exposure to the U.S. market. Accessing the U.S. market this way allows you tap into the preferential exchange rate that ETF companies get compared with the rate retail investors pay. If you invest in U.S. stocks in a registered retirement savings plan, registered retirement income fund or tax-free savings account, make sure your broker offers a U.S.-dollar version of these accounts (this is commonly available for non-registered accounts). In a Canadian-dollar RRSP, RRIF or TFSA account, your U.S. dividends and the proceeds from the sale of U.S. securities will be automatically exchanged into Canadian dollars and you’ll be charged accordingly. Another option is a fairly advanced technique for changing Canadian dollars into U.S. currency called Norbert’s Gambit.
2. Administration, maintenance, low-balance or inactivity fees
Slowly, the brokerage business is moving toward a standard fee, usually $25 or $30 a quarter, for clients who have small account balances or inactive accounts where no trades are generated. Some firms apply these fees only to cash accounts, others to all accounts.
A few brokers also charge annual administration fees of $100 on RRSPs and RRIFs with balances below $10,000 to $25,000.
Account maintenance fees can sometimes be avoided by, for example, setting up preauthorized contributions to your account, by having both a cash account and a registered account, or by making a few trades. If you do end up paying a $100 fee on a $12,000 account over a year, your returns are reduced by 0.83 per cent.
What to do: If you’re starting out as an investor or have a modest balance, don’t open an account with a broker before you find out (a) what maintenance, inactivity or admin fees you might have to pay and (b) what steps you can take to avoid these fees. You do not want to learn about these fees after seeing them deducted from your account.
3. ETF fees
The cost of owning a portfolio of basic index-tracking ETFs is within sight of zero – as low as 0.06 per cent or so for Canadian equity funds. But in its drive to grow, the ETF industry has introduced a new generation of products with more complex strategies and fees of 0.5 per cent to 0.7 per cent, or higher.
We’re talking here about the management expense ratio (MER), the most important indicator of the cost of owning a fund. You also have to be alert to the trading expense ratio, or TER, which tells you the costs a fund incurs for trading the securities in the portfolio. Basic index-tracking ETFs don’t do enough trading to even have a TER – you’ll see it expressed as zero. But actively managed ETFs may do enough trading to have a significant TER. If there is a TER, add it to the MER to get your all-in cost.
TERs are listed in the management reports on fund performance that are available for all ETFs and mutual funds. You can find the management report for an ETF by going to its profile on the issuing company’s website and looking for the “documents” link. When you have the management report open, head to the “ratios” section.
What to do: Be cautious about buying higher-fee ETFs unless you’re convinced they add value beyond the cheaper core ETFs tracking basic stock and bond indexes. Always check the TER for funds that are actively managed or use a screening process. You get a five-year view of the MER and TER when viewing the management report. Look for funds with declining MERs and consistently low TERs.
4. Mutual fund fees
Note to the investors who held a collective $35-billion in mutual funds at online brokers as of March: Unless you own a Series D version of a fund, you’re very likely overpaying on fees in a big way. Series D funds are for do-it-yourself investors who neither want nor receive advice. They have lower MERs than standard funds because they have largely stripped out payments to advisers and their firms, known as trailing commissions.
Trailing commissions can account for 0.5 to one percentage point of a fund’s MER, so they’re significant. Minimizing them is crucial if you’re a DIY investor because online brokers are prohibited by regulators from offering the kind of service and advice that advisers provide. You do not want to pay for service you’ll never get.
Online brokers typically default clients to Series D funds when placing orders, providing they’re available. Brokers have also taken steps to get longtime fund-holding clients to switch to Series D. Still, it’s possible that some investors still hold conventional funds with full trailers in their DIY accounts.
What to do: Stick to Series D funds, or funds offered by low-fee fund companies that don’t pay trailing commissions. Examples are Mawer, Leith Wheeler, Steadyhand and GBC. Also, check any funds you’ve owned for many years to ensure you’re not paying full trailers.
5. Transfer and withdrawal fees
Brokers typically charge about $50 if you withdraw money from an RRSP (partial, not the full account). On RRIFs, most brokers let you make scheduled withdrawals at no cost, but charge $25 or $50 for extra ones. To date, there seem to be no fees for taking money out of a TFSA.
The highest transfer fees apply when you move your account to another investment firm. They range from $125 to $150 and apply to all types of accounts.
What to do: When transferring an account to another firm, ask it to pick up the tab for your previous broker’s transfer-out fee.
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Rob Carrick