If I were to ask you what you’re invested in, many would say they have mutual funds from their banks or investment companies.
If I ask you how much it costs you every year to have these mutual funds, most would say “nothing.”
Step back and think about this.
Are all these companies and their financial advisers working for free to ensure your financial success?
Are all these advisers working for non-profit companies?
Management Expense Ratios
Enter MERs (Management Expense Ratios).
It includes expenses that are incurred to operate the mutual fund, such as:
- investment management fees,
- marketing and administrative fees, as well as…
- the fees they pay to the advisers that sell the mutual funds (trailer fees).
They are expressed as a percentage of your mutual fund’s value, and this is the yearly cost of your mutual fund.
Never heard of them? Not surprised. Most are unaware that MERs even exist!
These fees are subtracted off the fund return every year, whether or not the fund makes or loses money.
What does this mean? Say you have $100K invested in mutual funds with a MER of 2.35%, which is the average MER in Canada (based on Morningstar data)...
How much does this cost you every year?
Every. Single. Year.
Here’s the thing: We live in a country that provides mutual funds with some of the highest MERs in the world. (More on this later. But just for comparison’s sake, the average MER in the US is about 1.3%).
The stock market moves up and down so your mutual fund value will increase in some years, and decrease in others.
The one thing that remains consistent is that the mutual fund will take their $2,350 (approximately, the 2.35% is based on your fund value, so if your funds go up, you will be paying more than $2,350) every year. Without fail.
Own it for 5 years, and you would have paid the mutual fund company $11,750. Shocking isn’t it?
This doesn’t take into account the other fees (called loads) that are slapped on as well (front loads, back loads, deferred sales charges).
But let’s focus on one thing at a time.
Related: How Compound Interest Works
So let’s assume we invest $100K in Franklin Templeton’s Quotential Balanced Growth Portfolio at the beginning of 2012 and did not touch it for 5 years.
To simplify the calculation, we will assume that the annual cost is based on the value at the beginning of the year (ie: for 2012, the annual cost is $100K x 2.31% = $2,310).
|Year||Beginning of year||Total Return||MER||Net Return||End of year||Annual Cost|
For those who hate numbers, ignore the calculation and skip right to the comments.
For those who feel naked if you don’t have your trusted calculator with you, please confirm my calculations!
Ultimately, we have $141,167 at the end of 5 years, which results in a gain of $41,167 from our initial $100,000 investment.
“Well, that’s not too bad! I didn’t have to lift a finger for that extra $41,167!”
BUT, how much did the mutual fund company earn over the same 5 years?
I wasn’t able to track down what Franklin Templeton pays its advisers to sell us this fund (it can be found in the prospectus but my Google skills failed me), but I’ve found that the trailing fees could be up to 1% of the asset value for every year you hold it. So we’ll just make this assumption for this analysis.
What’s the verdict?
You make $41,167 over 5 years, and your trusted financial advisor pockets over $5,980 made off of your hard earned money. Sweet deal, hey? Sign me up!
Do you know how much you’re paying?
But first...Why does Canada have the some of the highest MERs in the world?
Cause we’re willing to pay for it.
If we’re willing to pay for it, why in the world would a company reduce their fees? Voluntarily reduce the amount of money that goes into their pockets?
As investors, we need to become aware of the fees that we are paying. And choose funds with lower MERs.
What frustrates me the most is that most people do not even know what they’re paying every year!
If the investor is fully aware of the MER and is willing to pay it because they believe that the fund manager will outperform the market, then kudos to them.
Unfortunately, most are just blissfully unaware. Pretty expensive bliss though, hey?
So how do you find out how much you are paying?
The fees are disclosed in the prospectus and annual reports that EVERYONE reads, right? I found a simplified prospectus – it was ONLY 224 pages.
Buried in there is all the information about how much the mutual fund is ACTUALLY costing you.
Buyer beware, right? Otherwise, a quick search on Google should result in some answers.
CRM2 - Disclosure Finally!
Fortunately, in Canada, CRM2 (Client Relationship Model Phase 2) has been introduced.
What is that? Sounds like a Star Wars droid to me! It means that consumers should now be receiving more disclosure with respect to the mutual funds they own.
Dealers have until July 14, 2017 to deliver these reports to investors, which now must show how much money was paid to the dealer on the investor’s account during the previous year as well as the performance of the client’s investments.
Definitely a step in the right direction…
But apparently, according to this article, several billion in fees that Canadian investors pay will not be found on these reports.
Related: The 5W’s of Investing
Some final questions:
- What mutual funds do you currently have?
- What are the MERs that you are paying?
- Have you received your CRM2 report yet?
- Did you know that this was coming? If you have received it and actually opened and read it, what was your reaction to it?