Mutual funds are a popular choice for Canadians, especially for those who are just learning how to invest. They are easy to set-up at your local bank, and with as little as $25 or $50 a month investors can open a pre-authorized purchase plan to get them started.
Unfortunately, it is widely reported that mutual fund fees in Canada are the highest in the world. According to this 2009 study by Morningstar, Canada has notoriously high management expense ratios. Let’s take a closer look at the different types of mutual fund fees:
Management Expense Ratio (MER):
All mutual funds have a management expense ratio (MER), which is the day-to-day expense of operating the fund. The ratio is calculated by taking the fund’s operation expenses and dividing by the average dollar value of its managed assets.
The MER consists of fees paid to the fund manager, as well as accounting, marketing, legal and administrative costs. Canadian MER’s contain trailer fees, which are fees fairly specific to the Canadian market. Trailer fees cover the expenses and commissions for the professional advisor.
According to the Morningstar study:
- The typical investor in a Canadian fixed income fund pays a MER of between 1.25% and 1.49%.
- The typical investor in a Canadian money market fund pays a MER of between 0.40% and 0.89%.
- The typical investor in a Canadian equity fund pays a MER of between 2.00% and 2.50%.
As if mutual fund fees weren’t high enough in Canada the MER’s don’t even include sales commissions that investors may be subject to when buying or selling mutual funds.
This is a sales commission charged to the investor when they purchase a mutual fund. Front-end loads reduce the amount of your investment, meaning that if you invest $1,000 into a mutual fund with a 5% front-end load, $50 will come off the top of your initial investment and only $950 will be invested in the fund.
The typical maximum front-end load for a Canadian mutual fund is 5%. All front-end loads are negotiable between the investor and the advisor. The typical Canadian investor pays a front-end load between 4% and 5%, primarily because investors are unaware that this fee is negotiable.
Deferred Sales Charges:
This is a sales commission charged to the investor when shares of a mutual fund are sold. The financial advisor is actually paid the commission up-front, but it does not get subtracted from your initial investment. Instead, the fund charges an early redemption fee if the investor sells the funds within seven years. The redemption fee typically starts at 5% in the first year and then gradually declines until it reaches 0% after seven years.
No Load Funds:
No load funds are just as they sound, there is no up-front commission paid to the advisor, and there is no deferred sales charge upon selling the funds. The only mutual fund fees that investors will need to pay with a no load fund is the management expense ratio.
The advisor will still be compensated with an ongoing annual trailer fee as long as you hold the fund. The trailer fee is 1% but, as discussed earlier, is included in the MER of the fund.
Understanding Mutual Fund Fees:
Although mutual funds are extremely popular in Canada, investors need to do a better job understanding the high mutual fund fees that they are paying.
According to the Morningstar study; Canadian investors do not pay much attention to fees. Canadian investors are comfortable with the fees because they don’t know how low these fees should actually be. Assets tend to flow into higher-fee mutual funds because Canadian investors use financial advisors to help them make decisions. Advisors direct client assets to funds that pay better trailers. And since the trailer is included in the MER, the result is that assets flow into higher-fee funds.
Mutual funds are a great place for investors to get started, but not if Canada continues to have the highest mutual fund fees in the world. Don’t let your portfolio get eaten away by unnecessary fees. Shop around for cheaper funds, or look into ETF’s as a low-cost alternative.