Smart Passive Investing – the Winning Choice for the Retirement Saver

Smart Passive Investing – the Winning Choice for the Retirement Saver

The active vs. passive investment debate has gained considerable traction over the last five years or so. A big reason being the emergence of exchange traded funds (ETFs), a smart passive investment approach, as an alternative to mutual funds. A closer scrutiny on fees and their impact on net returns (i.e. end cash in an investor’s pocket) have also helped spark this debate.

Unbeknownst to many, a societal shift has firmly set in transferring the responsibility of retirement planning and saving from employers to employees (also known as “you”). With this in mind, a proactive and informed approach to retirement planning is a must for those looking to maintain or step-up their standard of living in retirement.

Future retirees’ investment strategy and day-to-day spending control are “1” and “1-A” when it comes to setting up the retirement you aspire to. Reasonable people will disagree one which comes first (I personally side with spending control).

Active Investing

Getting back to the title and with apologizes to the gifted students, as I like to do, let’s make sure we’re all clear on the basics.

As the name suggests, active investing involves the judgmental (some may prefer “strategic”) buying and selling of investments in an attempt to predict “winners” and “losers” (“timing the market” is another way to describe active investing).

Broadly speaking active investing is achieved in two ways 1) owing shares of individual companies or 2) purchasing units of a mutual fund which in-turn owns shares of companies (usually many companies in an attempt to diversify). To keep things simple, I’m ignoring fixed income investing (lending money and earning interest rather than buying ownership, such as bonds).

As the majority of individuals save for retirement using actively managed mutual funds, I’m going to focus there for the remainder of the post.

Your home can be a valuable asset to you if you need extra money to cover retirement expenses. When you retire you will have the option of using some of that equity in the form of a reverse mortgage. The terms of the loan include several reverse mortgage pros and cons.

For instance, you will be able to stay in the home for the duration of the loan, but as soon as you pass away or choose to leave the balance will be due. Also, you will not have to pay back any part of the money right away, but you will accumulate a lot of mortgage interest as time passes. Additionally, your home can be sold if you move or pass away and the balance is not paid, but other assets belonging to your or your family will be safe from seizure.

The Mutual Fund Leech – MER’s

money leech

The primary fee paid for mutual funds purchased at the big banks or similar institutions is calculated in the same way – as a percentage of the value of the mutual funds. The investment industry calls this fee the “management expense ratio” (MER) and it typically accounts for the lion’s share, if not all, of the total fee. The average MER in Canada is 2% but can be as high as 3% or as low 1% give-or-take (these fees are typically lower in the US). In a simple example, if your mutual funds return 5% and your MER is 3%, your net return is 2%.

Take care to understand the MER in any given mutual fund as these fees are taken even if your mutual fund declines in value. Over the long run a 1% to 3% MER will have a massive impact on your holdings, so it’s important you receive good value (by way of strong fund management and relative market performance) for the embedded MER fees you pay.

Passive Investing

passive growthJust like active mutual fund investing, passive investing involves investing in funds of pooled money (such as EFT’s) which in-turn owns shares of companies. The meaningful similarities stop there.

The companies owned in the pool of funds are predetermined and held indefinitely (hence a “passive” approach) as opposed to “actively” attempting to sort out “winning” and “losing” investments on a day-to-day basis.

The most popular form of passive investing, and the sole focus from here on, is broad market index investing via ETF’s. This basically means the investor owns a teeny-tiny fraction of every company trading on a major stock exchange(s). North Americans will be familiar with the TSX (Canada) and S&P 500 (US) indexes, home of essentially all the value of North American public companies.

Look at it this way – when a newscaster points out the TSX or S&P is up or down by such-and-such – well so are your investments held in your broad market index fund or EFT.

The other important difference is of course fees. The method for passive MER’s range from 0.5% on the high end to 0.1% on the low end in most ETF’s.

To start building the case for passive investing, this difference of a percentage point or two in fees over the course of 30+ years of retirement savings will put tens of thousands of dollars in one’s pocket and hundreds of thousands in a lot of cases. This ignores investment performance which I’m about to hit on.

Active vs. Passive Investing – the Facts

As mentioned, the most popular form of retirement saving is through actively managed mutual funds. However, an increasing number of investors (albeit still a vast minority) are turning to broad market index investing using ETF’s – and for good reason. Consider these points:

  • When factoring the differential in fees, over the very long term of 20+ years, being generous less than 10% of mutual funds outperform the passive broad market index strategy. On the surface 20 years may seem like a long-time; but really is not when accepting we should be saving for retirement from day 1 of what is a 40 year working career for most.
  • What are the odds you’ll be the smarty-pants that identifies an investment advisor who is going to put you in the ~ 10% of mutual funds who will beat the index? Well with reference to the above…about 10%. Talk about rolling the dice on your retirement.
  • The central argument put forth by active mutual fund advocates is that broad market passive strategies do not serve investors well in falling markets. Looked at in isolation this is damming – as explained investor’s returns will mirror the ups and downs of the stock market (excluding fees). However, empirical data from the 2008/2009 stock market crash is clear on the fact that when factoring fees, active strategies fared no better than passive. The real winners were the investment industry players who raked up heightened sales commissions with all the panicked buying and selling.
  • Still not convinced passive is the way to go? Read John Bogle’s book The Little Book of Common Sense Investing. John hammers home all of the above and deepens the argument by, amongst other things, getting into the negative impact of secondary fees (beyond the MER I’ve focused on) of mutual funds and tax inefficiency inherent in most actively managed products.

My Passive Investment Portfolio

To add some credibility, I have, as they say, serious “skin-in-the-game.” My entire do-it-yourself (DIY) retirement portfolio is made up of low-cost broad market index funds. Each is a Vanguard product and the MERs are ~ 0.10%. Portfolio as follows:

30% Canadian equity, ticker symbol VAB:CA

30% US equity, ticker symbol VTI

30% International equity, ticker symbol VXUS

10% Canadian fixed income (virtually all Canadian government bonds), ticker symbol VAB:CA

With this mix I’m invested in a significant portion of public companies worldwide. I’ve essentially hitched my wagon to the returns of the world wide stock market.

Bought into the passive argument but not ready for DIY investing?

Invest with an advisor who charge as a percentage of investment, normally referred to as a portfolio manager (PM), and insist they invest in passive low-cost broad market index funds.

The going rate for PM’s 1% of assets which means your total cost will be 1% + the MER on your funds which shouldn’t be much more than the 0.10% I’m paying. On balance this will still leave you better off than mutual funds charging 2%.

Another option is to try investing with a robo-advisor. Read all about it in a past post here. In a nutshell, robo advisors employ passive broad market index investing for an all-in fee of ~0.5%.

Final Thoughts

Take control of your retirement and insist on passive broad market index investing. This introduction combined with further research should make its superiority clear – be that over mutual funds or other alternatives.

My Saturday night is wide open…I’d love to hear and respond to views on either side of the coin. Happy passive investing!

The author, Pat Kenney, is a Certified Professional Accountant. He has worked in public practice at a local boutique CPA firm in Mississauga for 9 years. He currently holds a senior management position.



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  1. I think the folks at Sunlife Financial might even call that post impartial! The human mind can’t seem to understand how much of a difference 1-2% MER makes to your portfolio over the years.

    Are dividends from most ETF’s automatically re-invested?

    • The default would be not to reinvest dividends. However, as I understand it, some ETFs do offer the option.

      There is often a work around for those that don’t offer a direct dividend reinvestment plan. Through your brokerage, at the account level, a reinvestment plan can be setup to automatically reinvest income distributions into additional investments as you outline. For example, with my account at Virtual Brokers, it is setup to have 100% of my income (i.e. dividends + interest) reinvested in the four ETFs I hold (as noted in the post) in proportion to my target percentages.

  2. Active vs passive investing is something that had never been brought up by financial planners I spoke with years ago. I have recently entered the marketplace myself by purchasing blue chip stocks and just sitting on them. I h have done better in the last couple of years than past results through mutual funds. The MER’s kill you.

    Wish I had known more when I was younger about investing. Don’t you think that this should be on school curriculums? Thank you for this website. Very informative and easy to understand.
    Lin recently posted…Paint a Parrot with Colored PencilMy Profile

    • I agree 100% Lin that financial literacy should be part of the curriculums – both grade school and high school There has been movement here in many (if not all) of the Canadian provinces.

      The Federal government has also wised up and put a task force in place to better promote financial literacy tothe young and old.

      The Chartered Professional Accountants of Canada have also rolled out a coast-to-coast financial literacy program (the Community Connect Program). The guts of it is free hour long presentations on all topics financial literacy. Consider checking out their website for presentations in your area (if you’re in Canada).

  3. Also, what’s the difference between the management fee vs the MER?

    Which one should i pay attention to and does the other one mean anything?
    Ty recently posted…Smart Passive Investing – the Winning Choice for the Retirement SaverMy Profile

  4. Great questions Ty. I would be happy to clarify, thank you for your interest.

    The management fee is the fee paid to the fund manager and is a component of the MER. It typically accounts for the bulk of the MER (as evidenced in the screen shot you provided). When sourcing funds (mutual, index, ETFs or otherwise) the other fee to pay attention to, which is in addition to the MER, is the commission “load” paid to the advisor’s firm for selling a fund to a client. We’ve all heard of the dreaded deferred sales charge (DSC) tacked on when trying to liquidate mutual fund investments. Commission loads are always charged and are more typical with mutual funds. One sure-fire way to avoid is becoming a DIY investor.

    I’ll reply to the reinvested question under another post so as to inflate the response to this post. Stay tuned.

  5. Thanks Pat. Great post! I wonder what your thoughts are on the correct distribution of these funds in registered and non-registered accounts. Do you hold the etfs equally throughout or strategically allocate more to specific accounts (eg RRSP, TFSA, Non-Registered). Adds some complexity with US and international tax rules on dividends and returns.

    • Hi Jason, sorry for the late reply. You’ve introduced the third and final item impacting an investor’s net return – taxes (fees and gross investment performance being the other two).

      To be honest I’m still working on maxing out all my registered accounts. To answer you question though – when I introduce non-registered accounts in future, I am certain I’ll strategically allocate in an attempt to minimize tax. For example, holding fixed income investments in my TFSA to shield the high tax rate on interest income and placing Canadian dividend paying funds (i.e. VAB:CA) in the taxable account given the more preferential tax treatment on dividends (and capital gains if applicable).

      A simple tax efficiency strategy I employ now is owing the two foreign holdings in my RRSP rather than TFSA as dividend withholding tax is refundable only in the RRSP (the rules can vary across countries based on the tax treaty). RESPs are treated the same as TFSAs in this regard as well.

      As far as I can tell, the best resource for tax-smart ETF investing is:

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