1. Management Expense Ratio (MER)
In simple terms, the MER tells you how much it costs to own a mutual fund. It's preferable to have a low MER than a high one when selecting funds.
Here's how the MER works. First, almost all the fees associated with running a fund are gathered together, including management and administrative fees. Next, these fees are compared to the total assets in the fund. What you end up with is a ratio showing you the percentage of the fund's assets that are eaten up by fees every year. Of course, those assets aren't just sitting there. They're invested in stocks, bonds and other stuff and hopefully earning a return that offsets the fees charged by the fund. Want to know how much a fund needs to make to break even? Just look at the MER. If it's 2.5 per cent, then a gain of 2.5 per cent is needed to get to the break-even point.
One of the most common fund questions I get from investors is, Do fund returns reflect the impact of the MER or not? The answer is yes. Fund companies publish net returns in virtually all cases. Put another way, fund companies take their cut before investors get paid.
MERs are not closely guarded secrets. You can get fee information on fund company websites, in fund company brochures and from websites like Globeinvestor.com and Morningstar.ca. Still, many investors are, by and large, clueless about the cost of owning funds. It's so easy— just check the MER.
I said earlier that the MER includes almost all the fees associated with a mutual fund. Curious about what isn't included? Mainly, trading costs— the brokerage commissions a fund pays for buying and selling securities. These trading costs can add as much as one percentage point, perhaps even more, to a fund's total cost, depending on how much trading a fund manager does. You can find hard information on the cost of trading in a mutual fund's semi-annual management report on fund performance. Look for the trading expense ratio, or TER, which expresses trading costs as a percentage of fund assets. Add the MER to the TER and you've got the total cost of owning a fund.
2. Trailing Commission
Also known as trailer fees, or just trailers. Never wondered how investment advisers who sell mutual funds get paid? You're not alone— a lot of investors are sold funds by advisers without having a clear picture of how the adviser is compensated for the transaction and subsequent service on your account.
Now that you've read the preceding section on management expense ratios, you know all about the big package of fees that eat into a fund's returns. A major component of those fees is the trailing commission. If you own an equity fund with an MER of 2.25 per cent, it would be typical for one percentage point to be accounted for by trailers. The trailer is paid by the fund company directly to the adviser, who shares it with his or her firm. Let's hope you're getting great service from your adviser, because he or she is getting paid well through trailers, regardless of how your account is doing.
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Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.
