Let us go back to basics!
The whole point about many products is to provide a managed vehicle that provides us access to lower and higher risk asset classes.
But what if the return that we were looking to get by buying the product was reduced by the product itself?
Would this reduce the benefit of the product and defeat the objective?
If it were to defeat the objective what is the point of the product?
The additional return on stock market investments over and above the return you get on cash is the return you get for taking the risk of equity investment.
The only point you take the risk is for the return. If charges eat up part or even all of the return, you are still left with the full risk.
It is a fact that today's transaction and management charges eat up a substantial element of the additional return you get on stock market investments.
There wrap accounts with annual management charges of 3% or more, there are mutual funds with annual management expenses of 2.5% or more, their are balanced funds which charge 2% or more for managing the cash and fixed interest portion of the portfolio, there are bond funds which take away the additional return on fixed interest. Also, do not forget to factor in the initial transaction costs.
Over very long period of times stock market investments outperform lower risk assets, but the differential between the two is not as great as many would think.
According to the London Business School's "The Millenium Book", a study into historical asset class returns (2000), Canadian equities produced an annual real return of 4.6% above the return on bonds over the period 1900 to 2000.
Most mutual fund charges would at least halve this return and many wrap accounts would eat into 2/3rs of the return before we even look at transaction costs. Also, this is historical return. Today's markets are much more highly valued than they were for most of the last century and it is expected that future returns on investment from this point on will be lower.
For individuals looking to draw down on capital over time, the combination of high transaction and high annual management expenses effectively invalidate the rationale for having a managed equity component as well as managed fixed and cash components.
Today's product offerings and today's financial services industry are failing the investor and ignoring the realities of risk and return and proper portfolio construction planning and management.
Most products are notoriously expensive because they are more complex, they need to be sold and there are far more individuals involved in the overall process. Products really, invariably, make money for the industry and the risk for the future is that the financial services industry will be the only party to the transaction that will on average make a return from investment products.
Managing portfolios does cost money, but it should not cost anywhere near the amount it currently costs private investors. It may be tempting for individual investors to ignore the issues and seek comfort in the illusion that their advisor needs to earn a return too.
It is therefore important that investors ask for information on all transaction and management costs associated with the management of their assets. It is important that an advisor justifies their chosen asset allocation vehicles and it is important that advisors provide regular performance analysis so that the individual investor can assess whether or not they are getting value for their money.