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The Longterm Cost of Higher Management Expense Ratios (MER’s)





You’ve all heard it before from books, personal finance blogs and newspapers to keep your investment expenses low. But does it really matter if your portfolio management expense ratio is 2% instead of 0.30%? Lets take a look.

Lets assume that the ETF portfolio is a typical global index portfolio using iShares ETFs of equal weight. I realize that the portfolio can be cheaper if we used some Vanguard ETF products, but lets keep it simple for now.

  • XIU 0.17% (Canadian Large Cap Index)
  • XSP 0.24% (US S&P 500 Index)
  • XIN 0.49% (International MSCI EAFE Index)
  • XBB 0.30% (Canadian Bond Index)
  • Avg: 0.30%

Lets also assume that we can put together a diversified actively managed mutual fund portfolio for a MER of 2%.

Even though we know that greater than 75% of all mutual fund managers do not beat the index, lets assume that the index ETF and the mutual fund portfolio’s have the exact same performance before fees.

Lets also go with both portfolios returning 8% before fees over 20, 25 and 30 years with $10k invested initially.

Type Avg MER Growth 20yrs 25yrs 30yrs
ETF Portfolio 0.30% 8% $44,087 $63,884 $92,570
Active Mutual Fund Portfolio 2% 8% $32,071 $42.919 $57,435
Difference - - 37.5% 48.8% 61.2%

This just goes to show, a seemingly small MER difference can make a HUGE impact on your retirement funds over the long term. Over 30 years, reducing your annual fees by 1.7% can result in a portfolio that is 61% larger. Even if the MER difference was only 1%, over 30 years, it would result in a 21.6% disparity.

Certainly puts the management expense ratios in perspective now doesn’t it?





21 Comments, Comment or Ping

  1. From what I have noticed, there are a lot of mutual funds beating their reference index BEFORE MER’s. The fact that we are paying such high amounts in Canada for MER’s is ridiculous.

    Do you have any idea why we, once again, pay a higher price for nothing? It seems that we are one of the country with the highest MER’s average…

  2. 2. Gerard

    Should that be reducing MER fees by 1.7 percentage points rather than 1.7% ?

  3. I agree and I still don’t know why many fund managers are still around. Is it because people don’t know that most of them cannot beat the market?

  4. 4. DAvid

    Frugal Trader states; “Even though we know that greater than 75% of all mutual fund managers do not beat the index”

    This is a bit of a misnomer. Here is an example of a Value Fund Manager who also does not ‘beat the Index’.
    http://www3.telus.net/NFtoBC/Images/Example.bmp
    However, I believe most would be happy to be invested in this portfolio. While I agree that many Funds may not perform as well as they could, and some do not beat the index, a better benchmark would be to assess a longer time, rather than annually. A manager such as shown in the link may not beat the highs the market shows, but if he reduces the losses in poor years, your portfolio rises more quickly.

    For the hands-off investor, ETFs may provide an inexpensive way to enter the market, but if you are choosing to invest with that level of involvement, you can also access managed funds at about half the usual MER. So, if as the Financial Blogger says, managed funds beat the market by less than their MER, possibly some would be an advantage if you purchased the lower MER versions.

    As with all advice, YMMV.

    DAvid

  5. DAvid, do you have any examples of mutual funds that you like? From my experience, Chou and Sprott stand out among the crowd.

  6. I have a question on XSP, which cover S&P 500 and its ridiculously high 0.24% versus 0.08% from SPY which is the US ETF for that.
    That’s a really nice way from the canadian underwriter to open the fund for S&P 500 companies for Canadians, and then simply purchase the SPY’s, while pocketing 0.16%/ year as passive income.

  7. DGI, a portion of the MER for XSP is for currency hedging. I agree that SPY is a better ETF as hedging isn’t as effective for the long term investor. I also like VTI for US exposure.

  8. 8. DAvid

    Frugal Trader,
    I’ve been following those, and Cardinal Capital. I would have liked to hitch my wagon to Pabrai Funds, but he’s untouchable now. Also I look to a few individual stocks, including Fortis, Shaw, and Sask Potash. The Banks should be examined just now, as there may be some bargains, as should energy and agriculture (expanding second & third world economies) Green energy and precious metals (high tech).

    DAvid

  9. 9. Josh

    The thing you are missing is that if any of these pay you dividends you will need to incur trading expenses.

    Over the course of a year I bet you pay more than 2% in trading fees back to your bank.

  10. Josh, there aren’t any trading fees for receiving dividend distributions.

    Are you talking about if you wanted to “reinvest” the dividends? Most discount brokerages will allow you to re invest the dividends for free providing that the dividend is enough to purchase at least 1 share.

  11. Frugal Trader,

    I didn’t know that canadian companies “hedge” foreign ETF’s. I haven’t checked this for a fact, but I have always thought that most US foreign funds/etf’s do not hedge their positions. This makes me want to read the statements from my fund company more careful..

  12. 12. Madfish

    Hi Frugal Trader. Investment newbie here, and a proud owner of some CIBC mutual funds with a 2% MER. And of course I’m not so proud anymore after reading this.

    My question is, how do I get YOUR type of 0.3% MER “fund”? Also, I suppose gains/losses in these funds are counted as capital gains/losses and are taxed more favourably than interests?

  13. Madfish, if your account size is fairly large (ie. > $25k), it may be worth your while to switch to index based ETF’s. Even though ETF’s are much cheaper than mutual funds, they aren’t for everyone. If you’re the type to put in a little bit every month, then index mutual funds may be a better product. If you were to switch to the CIBC index based mutual funds, you would cut your MER in half.

    To get the MER described in the article, you would have to open a discount brokerage account and purchase the ETF’s separately. Gains/losses for taxation purposes only matter if they are sold. But yes, they would be counted as capital gains. Distributions, are typically dividend based and are taxed favorably providing they are Canadian.

    Here are some articles to read up on:

  14. 14. Charles in Vancouver

    I settled on an ETF “couch potato” portfolio that I manage through Credential Direct ($19 commission per trade). I found out however, after purchasing my first funds, that Credential cannot DRIP any ETFs at all at present. Of course I was disappointed.

    My next instinct was to push the distributions into no-load funds, but CD has a minimum $1000 per transaction for mutual funds.

    But I am happy enough with the company that I devised a strategy. TD Canada Trust was my bank anyways, so I opened an eFunds account too. When quarterly dividends arrive, I transfer the cash to TD and purchase the eFund matching my most underweighted asset class. The same goes for regular contributions. Once any individual eFund breaks $2000, I will change it to ETF shares at the next quarter.

    It’s not as “simple” as I had hoped but I’m ultimately minimizing fees as best as I can :) This formula should keep my portfolio 80-95% ETFs at all times while maximizing the efficiency of each trade commission.

  15. 15. Josh

    Frugal Trader – LIES! ;)

    I will call BMO Investorline right now and ask them if I can have my ETFs be reinvested. I have a feeling they will mock me as they have a webpage that clearly outlines what funds can be DRIP’d.

    Do you currently do this with any of your iShare ETFs you mention? If you do I would like to know who you trade with and if you are happy with them… because I am not above switching accounts if it can get me free reinvestment in my ETFs.

  16. LOL! Josh, I rarely DRIP my dividends, but when I do, they are free. You have to note though that the dividend / quarter must be enough to purchase at least 1 share, or else they will sit as cash.

    Thus far, they are free with CIBC and Questrade. You can see the complete list here:
    http://www.milliondollarjourney.com/review-canadian-discount-brokerages.htm

  17. 17. QuikkCash

    Madfish, long time ago (1998) I owned CIBC MF with MER of 2.3%. Didn’t notice it until post 2000 when the market started to slide. Then it woke me up -> Why did I keep paying them when my money kept decreasing? If my money is not increasing why do I pay the managers for? I ditched the MF.

    DGI, XSP and XIN started hetching about 2 years ago?? before that they didn’t.

  18. 18. Madfish

    FrugalTrader: Thanks for your information. Yeah, I intend to put a little bit of $ into it every month. Maybe what I should do is take my current lump sum of fund over to ETF and start a new index based fund for my subsequent monthly savings.

    I’ll worry about that after I finish writing (and know that I have passed) my comprehensive exams…

  19. 19. Cannon_fodder

    For those that have more $ to invest, or have a wrap account, you may have access to lower MER versions of some MFs.

    Of course then one can make the case that if you have that much money perhaps you have sufficient to build your own ‘mini-ETF’ by buying equities directly with a low commission broker.

  20. 20. Mark in Nepean

    Good article, but I would caution that many mutual funds post returns that are post-MER fees.

    My point?

    If you have a fund that has consistency beaten the index over the last 5,10 or even 15 years, why not keep it?

  21. 21. Big E

    I was compiling information comparing the funds I purchase through my advisor so I can justify taking control of it myself and buy ETF’s, only to find that its performance was comparable. Has the fund just been lucky over the last couple of years?

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