Have you ever wondered what is a management expense ratio (MER)? It’s a fee that investors have to pay for many products such as mutual funds and exchange-traded funds (ETFs). Some people don’t even realize this fee is being paid since it’s automatically taken right out of your investment gains. To be clear, even if your investments go down in value, you’re still paying an MER.
So why does your MER matter? 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 over your investment lifetime, those fees could up costing you tens of thousands of dollars, if not hundreds of thousands. That’s why you need to know what is a management expense ratio and how you can reduce it.
What is a management expense ratio?
A management expense ratio is a fee that investors need to pay to the investment provider for running certain investments such as mutual funds or exchange-traded funds (ETFs). A quick example would be if you invested in a mutual fund with a 2.5% expense ratio, your cost would be $25 for every $1,000 invested. Sounds pretty straightforward forward but it’s a little more complicated than that.
MERs usually consist of a few different things with the management fee for the portfolio manager 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 management expense ratio that you pay which obviously adds up over time.
The MER also includes operating expenses such as transaction costs, office supplies, record keeping, administrative costs, 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.
Management expense ratios are different from management fees. MERs are what the fund charge while other companies such as robo advisors may charge you another management fee on top of the MER. This management fee usually isn’t more than about .50%, but if you combine that with an index fund that charges a .50 MER, your total fees for that found would be 1%. That’s still much lower than mutual funds.
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 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.
It’s also worth mentioning that the most expensive funds don’t necessarily mean you’ll get better returns for your funds’ investment portfolios.
How much am I paying?
Now let’s look at it strictly from a fee 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’m not expecting everyone to become DIY-investors, but there are so many different options such as robo advisors and Tangerine investment funds, there’s no reason we can’t reduce our management ratio. Seriously, it’s so easy to transfer your RRSP to a robo advisor such as RBC InvestEase, Justwealth and Wealthsimple.
How do I find out my MER?
Every mutual fund and ETF has a prospectus available to potential shareholders that lists the MER. In addition, you’ll also find the following information on the prospectus:
- Fund name
- Portfolio manager names (if any)
- Fund’s assets
- Net asset values
- Summary of fund goals
- Historical data on the fund
- Distribution fees
The prospectus will give you a clear idea of what the funds’ goals are and how it’s performed since its inception. Note that the MER is automatically factored into the gains. For example, if the fund is showing a return of 5% in the last year, the MER has already been subtracted.
If you’re new to mutual funds and WTFs, a good place to start is Morningstar. They provide market research for investment products. You’ll quickly be able to research different equity funds, total fund assets, any transaction fees, and even what the administrative fee is for different brokers.
Should you switch funds because of the MER?
Since mutual funds have an average expense ratio of 2% to 2.5%, you should definitely consider switching to funds with lower expense ratios. Better yet, switch to an ETF since there will be no sales charges or sales loads to pay.
There are so many all-in-one ETFs these days from reputable companies such as Vanguard that charge an MER of less than 0.50%. Why pay a high mutual fund expense ratio when you don’t have to? As I’ve already pointed out, the savings can be considerable. That said, you do need to do some basic research first to understand why buying index funds with a low MER is the ideal solution. You would also have to open an account with a discount brokerage so you can purchase the funds on your own. For reference, all of my investment accounts have a single ETF.
However, if you’re a high-net-worth individual who gets additional services from your financial advisor such as estate and tax planning, then the additional fees may be worth it. That said, if you’re getting those kinds of services, you’re probably better off paying a fee-only planner.
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. Now that you know what is a management expense ratio, don’t you want to start saving money? The purchases you make and a fund’s expense ratio can have a huge impact on your investment objectives. By reducing your fund fees, you could potentially increase your net worth.