The REAL Cost of Mutual Funds

If I were to ask you what you are 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?

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 2.5%, which is the average MER in Canada. We are fortunate to live in a country that provides mutual funds with the highest MERs in the world! (Average MER in US is about 1.1%). So how much does this cost you every year? $2,500! Every year. The stock market moves up and down so your mutual fund value will increase in some years, decrease in others. The one thing that remains consistent is that the mutual fund will take their $2,500 (approximately; the 2.5% is based on your fund value, so if your funds go up, you will be paying more than $2,500, and vice versa) every year without fail. Own it for 5 years, and you would have paid the mutual fund company $12,500. 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.

So let’s assume we invest $100K in Franklin Templeton’s Quotential Balanced Growth Portfolio at the beginning of 2006 and did not touch it for 5 years. The returns were taken from here: http://www.franklintempleton.ca/ca/retail/en/pdf/downloads/advisormonthly/fundreports/pub/658.pdf

Based on the footnote, the annual return is the total return for the year, and does not take into account the MER (based on my understanding). If the annual return does already include the MER, the numbers would change, but the resulting message will remain the same. To simplify the calculation, we will assume that the annual cost is based on the value at the beginning of the year (ie, for 2006, the annual cost is $100K x 2.24% = $2,240).

Year

Beginning of year

Annual Return

MER

Actual Return

End of year

Annual Cost

2006

100,000

9.90%

2.24%

7.66%

      107,660

             2,240

2007

107,660

-0.20%

2.24%

-2.44%

      105,033

             2,412

2008

105,033

-25.40%

2.24%

-27.64%

         76,002

             2,353

2009

76,002

25.50%

2.24%

23.26%

         93,680

             1,702

2010

93,680

9.60%

2.24%

7.36%

      100,575

             2,098

 

           10,805

AHHHH numbers! 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 calculation! 🙂

Ultimately, we have $100,575 at the end of 5 years, which results in a gain of $575 for our initial $100,000 investment. How much did the mutual fund company earn over the same 5 years from our account? $10,805. 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 $575 over 5 years, and your trusted financial advisor pockets over $4,800. Sweet deal, hey? Sign me up!

So why does Canada have 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.

Have you heard of MERs before? What mutual funds do you currently have? What are the MERs that you are paying? Please share below and take a look at what your family and friends are paying every year. If you have trouble finding the MER for your mutual fund, post a comment and I will try my best to track it down for you.

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11 Comments (+add yours?)

  1. Angie
    Dec 07, 2011 @ 17:56:04

    So what can you do about these MERs?

    Reply

    • Vicky Vo
      Dec 07, 2011 @ 18:09:43

      Unfortunately, you can’t get rid of MERs, as it does cost money to run and operate a mutual fund. What you can do is find the lowest cost index mutual funds possible, and save yourself tons of money this way. You can also build a portfolio of index ETFs(Exchange Traded Funds), which sport some of the lowest MERs in the industry. I will blog about these shortly!

      Reply

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  4. IRT
    Jan 29, 2012 @ 08:22:43

    Hi Vicky,

    I really like your blog. What do you think of index funds that have low MERs. Like the TD e-series funds?

    Reply

    • Vicky Vo
      Jan 29, 2012 @ 23:12:29

      I would recommend the TD e-series fund for anyone who has a portfolio of less than $50K or for those who do not want to deal with ETFs. If you are used to contributing each month to a mutual fund, these funds are a great alternative! The MERs for these funds are a bit higher than ETFs, but MUCH lower than your average MER for mutual funds in Canada, so you’re already ahead of the game. Is this what you are currently invested in?

      Thanks for dropping by!

      Reply

  5. IRT
    Jan 30, 2012 @ 04:11:38

    Vicky,

    I have been doing a lot of research this past year and I came upon index funds. I had initially invested ($10k) in some mutual funds years during my young and clueless days. The MF’s dwindled down and weren’t performing like I hoped. Never should’ve trusted my bank’s adviser. Obviously, she was trying to sell me on their higher MER MF’s back then. I was young and putting money away per pay check for my first real job was appealing.

    I’ve now taken steps to convert them to index funds and hopefully I’ll be on track again. I didn’t have a clue about MER’s back then. Some of the funds had MER’s of about 1.5-2.2%! I’ve converted them to index funds that is now at 0.68-0.72%. That’s a huge difference. And in general I’ve read that index funds do better than managed funds anyways. From my own experience, the actively managed funds have done nothing but compound my money inversely. I have yet to look into ETF’s. Maybe you can do a write up on it? Thanks for your advice.

    Reply

    • Vicky Vo
      Jan 30, 2012 @ 04:52:50

      0.68% – 0.72% is so much better, hey? You’re giving your portfolio a 0.82% – 1.48% head start every year! I will definitely do a write up about ETFs as well as mutual funds soon!

      Reply

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