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moneysense.ca, 1/12/09
Comparing Mutual Fund Fees and Harmonized Sales Tax
Current issue:
Tom Bradley of Steadyhand Funds recently confessed that while he has an axe to grind, he is hopping mad about the negative impact of HST on investors:
The impact of Ontario and British Columbia’s harmonized sales tax will be negative for investors. No matter who you want to blame – the government or the investment industry – there is no getting around the fact that resulting higher all-in fees, compounded over a long investment horizon, add up to real dollars. For a long-term investor, it will be the difference between an Audi and a Taurus, or golfing in Florida versus watching the Battle of the Blades on CBC.
It is true that the HST is an additional burden that penalizes investors saving to meet their financial goals. But it is mutual fund fees that hurt investors the most, not the HST. If mutual fund fees have the effect of a mortal wound on investor portfolios, the effect of the HST would be akin to a paper cut.
Let’s consider the case of Investor A who puts $100 to work in the equity market and earns an average of 8% over 25 years. At the end of 25 years, Investor A’s initial investment has grown to $685. Investor B also adds $100 to his portfolio but buys the typical mutual fund charging 2.5% in fees. Since B’s returns have dropped to 5.5% net of fees, his investment only grows to $381 (or 45% less than A). If B had paid a 8% HST on his mutual fund fees and his returns dropped to 5.3%, his investment would have grown to $363 (5% less than B and 47% less than A). Of course, a 5% difference is nothing to sneeze at but the reason B is driving a Taurus and watching Battle of Blades on CBC isn’t the HST; it’s the sky-high mutual fund fees.
Update: Michael James points out that the effect of fund fees is worse than 2.5%. Since mutual funds charge a MER on a daily basis on assets under management, the net returns at the end of the year is less than 5.5%. It is more like 1.08*0.975 -1 = 5.3%. The returns net of MER and HST is 5.084%. I’ll update the numbers in the post a little later in the day. Thanks Michael for pointing out the error.
moneysense.ca, 1/12/09
Mutual Fund Fees are a reason for any investor to consider investing in stocks directly, using the same principles of diversification.
Oh, and the HST – a money grab…Canadian Style.
Harmonized Sales Tax, makes it sound like we are all sitting around a campfire singing Kumbaya … as usual it isn’t.
Harmonize all the taxes together and then HIDE THEM, then the consumer won’t care!
Thanks for the dose of sanity. All these people whining about the impact of the HST on investors need to give their heads a shake and realize that the fees themselves are 12x more than the HST.
This tax is also applied to ETFs correct?
Even if that was the case low expense ETFs like XIU would only see a very slight increase.
Another example of why I enjoy this blog so much; timely, relevant, fact-based and a low hysteria factor.
Thank you, thank you and oh, by the way – thank you.
Rather than complain about the “harm” of the HST, mutual funds should be looking at ways to reduce their own fees. The biggest threat to most mutual fund companies is their arrogance. It’s no surprise that more and more investors are unwilling to give away 2% a year just to hold an index fund.
Why is the industrtry suddenly trying to “educate” us all about the impact of HST, and not their own fees?
A cynic would suggest that the industry is conditioning their clients to blame future underperformance on the HST, rather than the fund fees. It’s an easy target for them to transfer blame upon.
“….my wrap fund underperformed the index again!…..must be that darn HST!”
@Nick: To be fair, Tom Bradley is running an active fund with low MER and is a critic of wrap accounts, structured and other high-fee products. IIRC, the Steadyhand Canadian Fund charges 1.35% — a pretty low MER (for those wanting to go the active management route) compared to the average MER in the range of 2.5%. However, I do think Tom is wrong to lump the negative effect of HST with the much more negative effect of fund fees.
If one accepts the economic reasoning behind the HST (i.e. value added taxes are much more efficient than retail sales taxes), then this change should be very beneficial over the long run for businesses in Ontario and BC.
Jack Mintz (former President of the CD Howe Institute) did a report that estimated Ontario would gain 591,000 net new jobs, increased capital investment of $47 billion, and increased annual incomes of up to 8.8% or $29.4 billion over the next 10 years.
If you think the HST is a terrible idea, then such reports probably won’t sway you, but economists are pretty much unanimous that it’s a good idea. To the extent that this allows Canadian businesses to become stronger, then it could be a very positive thing for investors, not to mention most residents of Ontario and BC.
Al R
@Al R; That report included effects of other tax changes, not just the HST.
http://voiceoftoronto.com/wp/2009/11/proposed-hst-and-2009-ontario-budget-measures-would-create-jobs-increase-investment-and-raise-incomes/
“…proposed corporate income tax cuts and other recent tax changes would significantly increase jobs, boost capital investment and lead to higher annual incomes for Ontarians.
…small businesses would benefit substantially as the effective tax rate on their business investment would fall by more than half from 28.6 to 13.3 per cent.”
It doesn’t take a rocket scientist to see that reducing an effective tax rate by half would create jobs, increase investment capital, and generally be a good thing for businesses and the people they employ.
On the other hand, I can’t see how the HST benefits consumers. Taxing formerly exempt services increases the real cost of those services to the end user. If the real cost of those services sees an overnight hike of 7-8%, laws of economics dictate that there will be fewer users willing to pay the higher rate.
Reduced users will only negatively impact businesses, since the price increase does not increase the company’s profits, only the amount of tax collected and paid to the respective provincial government.
@AKA – It doesn’t make a lot of sense, IMO, to differentiate between workers and consumers, because they’re most often one and the same. At the very least, all workers consume. For the unemployed, this change would be of benefit, because it will create new jobs. Also, if incomes are projected to rise by $29.4 billion as a result of this change, that represents money that will be spent or saved. So it’s not like everyone is going to be poor and businesses will suffer as a result.
For certain services that were previously PST exempt, they will likely see some reduction in demand (because their relative prices will go up), but the real cost of some goods and services (clothing, consumer appliances, automobiles, computers, etc.) will actually decrease. According to Andrew Coyne of Maclean’s, when the HST was previously implemented out east “prices in the Atlantic provinces fell by 0.3 per cent, while some large items fell as much as 3.0%.” A TD Bank study quoted in the article projects prices will rise in Ontario by 0.7%, with the Ontario Chamber of Commerce putting the per capita loss at $70. A small price to pay, IMO, for the huge benefits this change should bring about.
The Coyne article is excellent if anyone is interested.
http://www2.macleans.ca/2009/11/23/a-few-kind-words-for-harmonization/
I need to learn more about the impact of this…particularly from a Quebec investor point of view.
If I have TD mutual funds (ie. their e-series), which are presumbly based in Toronto, am I taking a hit on the overheat? Is it the consumers in the province, or the business in the province that takes the overall hit? Should I be moving all mutual funds out of Ontario-based management companies?
What is truly offensive here is that the Ontario HST will apply to Alberta investors! Why should an Alberta resident have to pay for Ontario’s fiscal profligacy? Completely ridiculous.
@Roger – In the long term, fund managers may all relocate to Alberta for that reason!
@Patrick – It would be nice if that were true. However, it’s hard to imagine fund managers relocating to Alberta so that clients can save a few basis points! I’m sure that’s part of Ontario’s calculation.
From an investor’s standpoint, you can still vote with your money. Yet another reason to choose Vanguard over iShares Canada whenever possible. Or choose Mawer over Trimark, etc. This is true for all Canadians (including Ontario residents).