One of the most commonly talked about topics in the personal finance world is fees. Everyone understands fees, they’re charged for everything, so the common logic is to avoid them when we can since they can add up pretty fast. Eliminating small daily fees are great for improving our cash flow, but what all investors need to pay more attention to is the management expense ratio (MER) which is charged with many of our investments.
Interesting enough, Canada has the highest average management expense ratio in developed markets at 2.14%. For most of us, paying an average of just 2.14% for a mutual fund sounds like good value, but an MER should be viewed like those small daily fees we’ve been trying to cut out. If we can reduce the fees we pay, in the long-run we’ll be much further ahead and that could make a huge difference when we retire.
What is a management expense ratio?
A management expense ratio is basically an annual fee that is required for running certain investment such as mutual funds or exchange traded funds (ETFs). A quick example would be if you invested in a mutual fund with a 1% expense ratio; your cost would be $10 for every $1,000 invested. Sounds pretty straight forward but it’s a little more complicated than that.
MERs usually consist of a few different things with the management fee usually being the largest fund expense. Since someone actually has to run the fund, that’s where the management fee comes in. What gets tricky is sometimes your advisor may tell you they get a very small percentage for their services, well that price is part of the larger MER that you pay which obviously adds up over time.
The MER also includes operational costs such as office supplies, record keeping, legal fees etc. Although the MER covers most expenses, there can be separate fees that we pay such as front or back-end loaded funds which are commissions paid separately from the MER. This doesn’t apply to all funds so always ask for the details.
How does the management expense ratio affect me?
Some of us still believe that we’re getting value for paying a small percentage of our investments, but let’s take a look at how the MER eats into our returns. The following chart assumes the following:
- $100,000 initial investment
- $5,000 annual contribution
- 5% annual rate of return
|2.5% MER||1% MER||.50% MER||.20% MER|
Obviously, the lower your MER, the more money you have in the end. The MER percentages I’ve chosen are actually the average of the most common investments and are broken down as follows:
- 2.5% – Average mutual fund MER
- 1% – About the cost of using a robo-advisor or Tangerine investment funds
- .50% – About the cost of using TD e-Series index funds
- .20% – About the cost of a self-directed ETF portfolio
As mentioned, there are a few other costs associated, and if you’re a self-directed investor you will incur some trading fees so the above chart isn’t an exact science. The idea is to give us a general idea of why we should pay attention to our MER.
The difference between paying a 2.5% and .20% MER over the course of 25 years would be $168,452.00 in our above scenario. Think about how far that money could go in our retirement years.
How much am I paying?
Now let’s look at it strictly from a fees perspective. The following chart shows how much money we pay for our management expense ratio.
|2.50% MER||1% MER||.50% MER||.20% MER|
An average mutual fund will cost you $182,909.94 in 25 years, is that not insane? It’s impossible to get our MER down to zero, but you can see what a HUGE difference it makes on our bottom line. Most of our investment timelines last longer than 25 years, so by the time we retire we could have paid hundreds of thousands of dollars in fees if we stuck to regular mutual funds.
I understand that the majority of people have no interest in managing their money, but I do believe most people would prefer to have more money when they retire. The money we save by reducing our management expense ratio can greatly improve our lifestyle when we retire and that’s why we should take MERs seriously.