Expensive mutual funds should concern every investor. However, few truly understand the full cost of investing in mutual funds because they do not pay the fund fees and expenses directly.
The mutual fund fee calculator developed by the Investor Education Fund, an independent, non-profit organization set up by the Ontario Securities Commission (OSC) to educate consumers about personal money management, can help with this task. The calculator determines the management fees and operating expenses (but not trading expenses) for a dollar amount invested in a specific fund over a defined period.
Drawing on Morningstar fund data, the calculator is updated annually in June. It's easy to use. You simply choose the fund from the list provided, the holding period and the sales fees paid (if any), and input the dollar amount invested.
The calculator's database of Canadian mutual funds is extensive. I did notice that not all funds available from some companies were included, and the funds of a few companies were missing altogether. If a fund of interest is not in the database, you can look up its long-term return rate and fees charged and use the calculator's custom tab to find out the fund's cost.
To demonstrate the annual fees a hypothetical investor would pay, I created two demonstration portfolios, each initially valued at $100,000. The asset allocation for both of these balanced portfolios was 25% Canadian equity, 25% U.S. equity, 10% international equity and 40% bonds.
The specific funds I chose are for illustrative purposes only, though all of them have above-average Morningstar Ratings (4-star and 5-star) in their peer groups for their risk-adjusted past returns. You could argue that these funds provided better value historically for the fees they charge than funds that were average or below-average performers.
The first portfolio consisted of lower-cost funds more likely to be held by do-it-yourself investors: Leith Wheeler Canadian Equity Series B (MER 1.57%), Altamira U.S. Currency Neutral Index (MER 0.65%), Mawer International Equity (MER 1.57%) and TD Canadian Bond Index -I (MER 0.83%).
The below-average fees are attributable mainly to the fact that the sponsors of the Leith Wheeler and Mawer funds pay no trailer fees to fund distributors, and that the trailer fees paid by the Altamira and TD funds are well below the industry averages for their respective categories.
Along with their relatively low trailer fees, the Altamira and TD funds are both passively managed, so their portfolio-management costs are lower than for actively managed funds.
My second demonstration portfolio consisted entirely of actively managed funds that charge substantially higher management fees than those in the first portfolio. The main reason for this is the need for the fund sponsors to defray the costs of paying trailer fees to distributors of about 1% annually for equity funds and 0.5% for fixed-income funds.
The funds in this hypothetical portfolio were Fidelity True North Class B (MER 2.31%), Trimark U.S. Companies (MER 2.97%), BMO International Value Class (MER 2.58%) and CIBC Canadian Bond (MER 1.51%).
The first portfolio had a blended MER of 1.04% and incurred $1,077 in annual fees. Fees paid for the second portfolio which had a blended MER of 2.18%, were $2,243, over twice as much. (All MERs used in this article were as reported in the calculator.)
Fund fees are an ongoing charge, so the amounts paid by fund holders will grow over time. The custom tab of the Investor Education Fund's calculator is a quick way to appreciate this impact. It reports that investing $5,000 per year over 25 years at a 5% return yields an after-fee value of $250,567. The fees paid if the MER is 1.04% would be $26,915. If the MER were 2.18%, an investor would shell out $56,757 in fees.
The investment-fee calculator at www.buyupside.com, an independent U.S.-based investor-information website, provides a different perspective on the impact of fund fees. It reports the final fund value before fees, fees paid including the opportunity cost (future dollars lost due to fees), and the final value after fees. Testing the two blended MERs, 1.04% and 2.18%, for $100,000 invested in a fund with a 5% return rate over 25 years, produces some sobering results:
|1.04% MER||2.18% MER|
|Fund value without fees||$338,635||$338,635|
|Total fees paid||$77,885||$143,461|
|Fund value after fees||$260,750||$195,175|
|Reduction in future value due to fees||23%||42%|
Some fund investors also pay a point-of-sales fee, also known as a front-end load, of up to 5% when they buy a mutual fund. Others pay a redemption fee, also known as a deferred sales charge. These fees exert a further drag on returns.
For instance, in the above portfolios, with a 5% front-end sales charge, the fund value after fees for the 1.04% MER portfolio took a further hit of $13,037, while the value left after fees for the 2.18% MER portfolio was $9,760 lower.
Most fund companies are not particularly interested in highlighting the costs of owning their products. However, they are required to disclose fee information in their prospectuses, and in summary documents known as Fund Facts.
The "How much does it cost?" section of Fund Facts sets out the fund's fees and expenses, specifying the MER, trading expense ratio, commissions rates including front-end loads, redemption fees and trailer fees, and total costs per $1,000 invested.
As noted in the discussion paper on fund fees released in December by the Canadian Securities Administrators, there are no current requirements to provide clients with specific information about how much they paid in trailer fees and other dealer/advisor compensation embedded in the fund's management fee.
Only a few fund companies, direct seller Steadyhand Investment Management Ltd. being one, provide clients with account statements that show the dollar value of fees paid. If asked, some financial advisors might supply this information. The reality is that most fund investors will have to figure this out for themselves, and that's what makes fee calculators useful and informative.