Investing Series: What is an “MER” (Management Expense Ratio)?

This is a part of the Investing Series.

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Management Expense Ratios are a fancy way of saying that investors need to pay for the guy that they’ve hired to manage the mutual fund that you’re investing in, plus other fees (keep reading).

This hired financially-sound person will watch the portfolio and make sure that it follows what it says it was supposed to do as its strategy among other things.

I think this photo pretty much sums up how I feel about MERs that are not as LOW AS POSSIBLE:

WHAT MAKES UP AN MER?

• Management expenses: Investment research, marketing, the bank’s profit
• Dealer/Advisor Compensation or Trailer Fees
• Administrative Costs: Regulatory expenses, service costs, legal and audit fees
• GST (Canada): Goods and Services Tax

If you want to know exactly HOW much they take out of your account, it’s a bit tricker because it is taken out as a percentage of the entire portfolio of assets held at the bank in that mutual fund, not based on your money specifically.

This is what it looks like as a pie chart:

You can read a lot more about MERs here.

WHERE DO I FIND AN MER?

To find this “MER”, look around on the page that deals with that fund, and look for the part where it talks about fees; here’s an example:

HOW DO THEY TAKE OUT THE MER?

0.35% means that they take 0.35% of the entire assets of the portfolio, or out of the $422.78 million as of December 31st 2012, which obviously can change as assets will increase or decrease as the year goes on.

These calculations below are just a demonstration of how it works in general:

0.35% x $422.78 million = $1,479,730 a year, or $4054.05 a day

You only pay a portion of that $1.479 million a year, based on how many units you own.

With TD Canada Trust in particular, they take the MER out on a daily basis.

This amount will change as the funds assets grow and shrink, so I am fairly sure it isn’t based on just a single December 31 2012 number in this case.

If there’s more in assets by January 1st 2013, they will take the same amount of MER (that is the same percentage) out, just out of a bigger pot of money, which will end up as more than the $4054.05 a day.

This is calculated on a daily basis, which means the fee that you pay will also change on a daily basis.

Now do you see why everyone harps on MERs and making sure you don’t over pay?

Read: How and when is TD Canada Trust charging for their MERs?

In this particular example, let’s say you own $10,000 in this particular fund that charges 0.35% as an MER because it’s passively managed.

As I understood it, it works like this (Investors, please correct me if I’m wrong):

$10,000 / $422.78 million = 0.0024% is what you own of the entire fund’s assets.

0.0024% x $4054.05 = ~$0.10 a day

In contrast, if your actively-managed fund charged a 2.3% MER with the same assets of $422.78 million, this is what it looks like:

0.0024% x $27,220.08* = ~$0.65 a day

Yep. $0.54 extra in fees being eaten every single day you invest with them.

*Got this number of $27,220.08 by taking 2.3% x $422.78 million, and then dividing it by 365 days of the year.

BUT DON’T I MAKE MORE MONEY WITH HIGHER MANAGEMENT FEES?

You’d like to think so.

A question I asked myself at the start of all this investing was: Do these actively-managed funds actually return MORE versus passively-managed funds over the course of your investments?

The answer I got was: No. Studies have shown the contrary, which I will go more in-depth about in my Investing Series.

Over a life time, it really adds up, especially if you continue adding more and more money, and taking into account that inflation that also eats away at your future purchasing power each year.

The difference becomes even greater if you think about having $100,000 in the pot:

$100,000 = 0.024% of the fund’s total assets

0.024% @ 0.35% MER = $0.96 cents a day

0.024% @ 2.3% MER = $6.44 a day

We’re dealing in the DOLLARS now, not just in pennies of a difference in cost.

Update: Hat tip to Jared for catching my wonky late-night calculation and typos. You miss ONE space or a dot at 9 p.m. in a post and it screws everything O_o

WHAT IS A GENERAL RULE FOR THE COST OF A MUTUAL FUND?

There’s no rule, it depends on what the bank wants to charge.

If you want a benchmark for index-tracking mutual funds (a.k.a. Index Funds), I’d say around 0.50% and lower is “normal”, but you can find them as low as 0.15%, even in Canada.

Other actively managed funds start at 1% and go up to 2.5% or even 3% at times as an MER.

WHAT ARE ‘NO LOAD’ MUTUAL FUNDS?

Everyone talks about buying “no load” funds, but WTF does that mean?

No load means they don’t charge you to buy the funds.

I know, at this point you’re thinking:

But .. I’m GIVING my money to them.

They’re taking MY money to invest, and they still want to charge me money on top of that!?

Sadly, yes.

This is where banks ALSO make their money in addition to MERs, by charging you a friendly 5% sales commission on selling you a fund that you so desperately need to buy.

And that’s what an MER is.