The biggest way that DIY investors may boost their net return is the switch from high-fee mutual funds into low-cost passive index investing. However, those expensive bank, credit union, insurance company, or wealth-management firm funds are usually proprietary house-funds. That means that they cannot be held elsewhere. That is for good reason. The bank/broker uses part of those high fees to pay for the “free” advisors that sell those funds. So, those advisors may use this as an opportunity to try and “save the account”.
This page examines the common arguments used. One argument is that you are missing out on professional active management. That assertion has already been debunked elsewhere. The others have kernels of truth or play to human biases. This makes them potent. However, they are overblown when considered against the return-kill of high fees. It is important to be knowledgeable, if you get called. You must also to be comfortable with your decision, even if you do not.
Recognizing Proprietary Mutual Funds
The first sign of a proprietary mutual funds is that the name or symbol matches that bank/group that sold it to you. Often bank initials plus some numbers. The second clue is that is it called A-series. While there is no standard, A-series funds are usually retail, proprietary, and coupled to a bank advisor. The third clue is that the management expense ratio (MER) fees are very high. Usually in the 1.5-3%/yr range.
How To Transfer Proprietary Funds
To transfer money tied up in these proprietary funds, they must be sold to do an “in cash” transfer. They can’t be transferred “in kind”.
If you try to transfer “in kind” instead of “in cash”, then the sending institution often uses that as a reason to reject the whole transfer. That rejection is a hassle. For those transferring to Qtrade, the transfer request can be re-submitted on the Qtrade site. An email to customer support at Qtrade is also effective.
The best way to transfer proprietary funds is to do an “in cash” transfer right from the start. That will result in the sale and moving of the money to your new account the fastest. The speed still depends on the sending institution but is typically 2-4 weeks. If transferring to Qtrade, and it is taking longer than expected, then an email check-in with firstname.lastname@example.org may be helpful.
The Capital Gains Tax Boogey-Man
There are no tax concerns for transfer from a TFSA, RRSP, or RESP to the new account of the same type. They are all tax-sheltered. Selling funds for an “in cash” transfer from a tax-exposed account (personal or corporate cash/margin account), could trigger some capital gains taxes.
An unrealized capital gain is only tax-deferral. That may or may not mean tax reduction.
Triggering capital gains tax sounds scary. However, you pay the capital gains taxes now or in the future. The only difference to how much you end up with after-tax is the difference between your tax rate now vs. later. If your future tax-rate is higher, then tax deferral is actually worse. If your future tax-rate is lower, it is better. The future is hard to predict, and your tax-rate may not be much different.
Any tax-hit is usually made up very quickly by the fee-savings moving forward.
Remember why you are switching to low-cost DIY investing. For the years in between now and when you would have otherwise sold, your investment is likely to grow faster without the drag of high management fees. Moving from 1.5-3%/yr fees to 0.2%/yr fees will usually make up for any tax difference within a few years and the rest is gravy. For the rest of your investing life.
Here is a calculator that models the tax hit vs the fee-savings in a personal taxable account. It is pre-set with a large capital gain, low mutual funds fees, and the same income now and in the future. Spoiler alert: even with that worse than average scenario, the break-even point is one year & 19% more after-tax money in 20 years. You can change the inputs to your situation.
If you are concerned about realizing capital gains within a corporate account, don’t be too worried. It may actually be a good thing. Harvesting capital gains in corporate account may allow you to give out a tax-free capital dividend to fund your lifestyle. That is way less tax due now compared to paying out regular dividends.
Back-Loaded or Delayed Sales Charges
Delayed sales charges (DSCs) are fees charged when a mutual fund is sold. They generally decay over time (5-7 years). This is a deterrent for selling mutual funds that were recently purchased. DSCs were recently banned in Canada for funds sold after June 1, 2022. If transferring non-proprietary A-class funds, then they will automatically be switched to the lower fee F-class version without triggering a capital gain/loss. As mentioned previously, most A-class funds are proprietary and must be sold and transferred “in cash”.
Banned now. Nasty hangovers still possible. Usually best to take your medicine and move on.
Unfortunately, DSC fees from the funds bought before the ban still apply. The DSC fees can be pretty substantial (up to 6% and then decaying). So, if you are facing these, you will need to consider whether to rip off the band-aid now or later. You can play with the embedded calculator below. Usually, the dramatically lower fee-drag from DIY offsets the penalty in less than the decay-period of the fee. However, this is a decision that you must consider and make for yourself.
Fear of Missing Time in the Market
This concern is driven by the correct instinct that time in the market is important and missing time can miss some of the move up. You definitely do want to minimize the time that you have uninvested cash. The best way to do that when transferring accounts is to transfer assets “in kind” and then buy/sell to make desired changes in your new account. Unfortunately, you cannot transfer proprietary funds “in kind” and you will spend some period of time with uninvested cash.
I spoke to the folks at Qtrade and the best way to spend the least amount of time uninvested when dealing with those proprietary funds is to transfer “in cash”. They are sold to cash and the cash moved. You can then immediately use that cash to buy the ETFs you want once it moves to your Qtrade account.
Put the short-term risk of cash into the perspective of long-term fee-reduction.
When managing risk between two options, you must consider the probability of an event and its severity for each proposed course of action. The risk of missing the market while in cash for a couple weeks is of moderate probability and limited magnitude. The savings from fee-control are high-probability and moderate magnitude in the short-term, but huge magnitude over the long-term.
You cannot control or predict what the market will do during that brief period of time.
It could go up or down. However, if you do not make the change now, then you need to make it later (or accept long-term fee-drag). You cannot predict what the market will do later either. The fact that you have fee-laden mutual funds is a sunk cost. You cannot undo the performance drag from the fees of the past, but the sooner you change that moving forward, the better.
You must also put the probability and magnitude into perspective.
Is the market likely to go straight up by more than 5% during the brief time period that you are in cash for transfer? Markets rise about 70% of the time, but they tend to drop quickly and rise slowly. They chop around a lot along the way. So, it is unlikely that you will miss a massive straight up move. It is not impossible, but you also cannot predict or control it.
In contrast, if your mutual fund is costing you 2%/yr more than ETF investing, then you would make up being unlucky within a few years and the rest is gravy. Over a 15-year time horizon, that is 2%/yr which is 35% when compounded. You cannot control or predict the short-term movement, but the long-term fee drag is very predictable. Putting it off doesn’t make it go away. It just puts you further behind. You can control this.
Selling Low & Missing the Ride Back Up
This is related to the fear of missing the market, except it is being more specific to less diverse investments compared to investing in the broad market. For example, you made a bet on an individual stock, or a fund focused on a narrow sector. It is now down by 50% and you want to wait until it gets back to even before selling. There are biases that make this powerful, but also illogical.
We anchor the value of the holding to what we paid for it. However, it is actually valued based on the future prospects of company or industry group. That anchoring bias is illogical and a source of error if those prospects have changed from when we bought it. Markets efficiently price in all known information and probabilities so rapidly in the modern era that active managers cannot beat them consistently. Your bet on a company or sector was based on your, or your advisor’s, belief that the market had incorrectly priced it too low. An active management decision. If wrong, then the price may not recover as hoped for.
What are the odds that the bet was wrong?
There is a reason why active managers trail passive strategies. Market inefficiencies are fleeting and hard to take advantage of. Over 90% underperform (placed wrong bets). But the fund was doing so well before this. It is just a blip. Again, statistically funds that outperformed previously are likely to underperform the broader market by worse than random chance in the following years. So, the odds that you or your advisor were wrong when placing an active bet are high.
Placing narrowed bets on companies or industry groups is also statistically unlikely to succeed. A study of 90 years of market history showed only 4% of stocks account for the net market gain, more than half have a negative life-time return, and the most common outcome for a stock is a 100% loss. Those are not great odds and is why broad market funds are more likely to have a better outcome.
Don’t fall prey to sunk cost fallacy.
Sunk cost fallacy is when you have made a bad decision that has cost you money, but you don’t want to correct it because that means losing the money. The reality is that the money is lost. All that you can do is make the best decision moving forward. Otherwise, you are continuing to throw good money away after the bad.
Realizing a loss to make a better investment is super-charged tax loss harvesting.
Tax loss harvesting is selling an investment to realize the capital loss and then buying a similar (but not identical) investment. That harvested loss can be used to offset taxes from past or future capital gains. This does not matter for tax-sheltered accounts, but is a strategy used for tax planning in personal taxable accounts.
Getting rid of a high-fee or narrow-focused loser fund to replace it with a more evidence-based low-cost broad index fund is even better than tax loss harvesting. Not only do you get the tax-offset, but you are also replacing the losing approach with a sounder strategy for the future.