BlackRock Asset Management Canada, the biggest provider of exchange-traded funds in Canada, recently released a survey of 500 affluent Canadian investors and their current views on investing. Respondents held at least $500,000 in investments, not including their homes or employment-related pensions, so it's fair to say they have a vested interest in being informed.
Yet the report found that an astonishing 47% of the study participants who owned mutual funds believed their funds did not charge management fees. What were they thinking? Common sense dictates that the thousands of mutual funds available in Canada aren't managed free of charge.
The lack of knowledge about mutual funds that the BlackRock report implies is disturbing. In the interests of improving the financial literacy of Canadians, let's explore some basic but not necessarily well known facts about these popular financial products, and provide some money-saving tips.
Find funds with lower MERs:
First, let's make it perfectly clear: All mutual funds charge management fees. After all, fund managers and marketers have to eat. This fee is calculated as a percentage of the total value of the assets held by the fund and makes up the largest portion of the management expense ratio (MER). In addition, point-of-sales commissions payable to brokers and dealers may be embedded -- though not specifically broken out -- in the management fee of most load funds.
Most fund companies also pay ongoing commissions to the broker or dealer for as long as the purchaser owns the fund. This so-called trailer fee is paid out of the fund management fees and is supposed to compensate the sales person for advice and service provided to clients. These fees are typically in the range of 0.5% to 1% of fund assets. You won't find them broken out in your client statements, but they are disclosed in the fund prospectus.
Fund companies that pay much lower trailer fees -- or no trailer fees at all -- generally offer funds with lower MERs. Unfortunately, many financial advisors won't recommend these funds to clients, even if they are top performers. By doing a little research on your own using an online tool such as Morningstar's Fund Selector you could discover some excellent funds that your advisor might never mention.
Get rebates on your trailer fees:
Discount brokers do not give investment advice, but they still pocket trailer fees paid by fund companies for the funds held in their customers' accounts. A commendable exception to the rule is Questrade Inc., whose Fund Maximizer program rebates the trailer fees the firm receives for client's funds. Questrade charges a monthly administrative fee, so its program makes sense only for investors with fund assets valued at about $40,000 or more.
Buy cheaper direct-sales series:
Another friendly overture to do-it-yourself investors comes from RBC Financial Group, which manages Canada's largest mutual-fund family. It has created a D series of funds -- whose MERs are cheaper than the regular no-load funds sold through bank branches.
Currently, 41 RBC D Series funds are available through two RBC-owned channels: the discount brokerage RBC Direct Investing and direct-sales fund dealer PH&N Investment Services. Other restrictions include a fairly steep $10,000 minimum investment at RBC's discount broker. At PH&N, where direct investors can get advice on asset allocation at no extra charge, the minimum account size is $25,000.
Save by investing online:
Another low-cost alternative that's worth a look is the TD Mutual Funds e-series. All purchases, redemptions and other account activity for e-series funds must be carried out online. This series is available exclusively through TD Waterhouse discount brokerage and TD Canada Trust's EasyWeb Internet banking.
Lower your loads:
Sales commissions to buy mutual funds are not all created equal. You can save money on sales commissions by buying funds known as no-load funds, which do not charge sales commission either at the time of purchase (a front-end load) or at redemption (a back-end or deferred load.)
Front-end loads are based on a percentage of the amount invested in the fund. Since they're charged outside the fund, front-end loads are negotiable, so you can potentially save money if your advisor is willing to bargain. If you buy from a discount broker, the front-end load is cheaper still, since it's generally set at zero.
Avoid getting dinged on the back-end:
There is no commission deducted on a back-end load fund. The way it works is that: the fund company pays the commission to the seller at the time of purchase. However, there is a deferred sales charge (DSC) or redemption fee to pay when the fund is sold, unless it is held for a prescribed period (usually six to seven years). Low-load funds are back-end load funds with a shorter prescribed period, about two to three years, lower redemption fees and lower point-of-sale commissions.
Back-end load funds are best avoided, since they tend to charge higher management fees and investors may hold them longer than they should to avoid redemption fees.
Look for funds with lower trading costs:
Some fund managers trade frequently and run up substantial brokerage expenses. The fund must pay these expenses, which, of course, eats into profits. If the performance is good, the fund may still be worth buying. However, whenever the fund sells an investment, any capital gains are crystallized. You must then pay the income tax on these gains if the fund is held in a taxable account. Before buying a fund for a non-registered account, check the fund company's web site for its record of capital-gains distributions. All other things being equal, look for funds that manage their distributions to minimize your tax bill.
Costs are important, but don't stop there:
Cost-saving opportunities, while important, are but one aspect of mutual-fund investing. To become a well informed investor and ensure that these products serve your interests, you also need to educate yourself about how to: choose the best mutual funds for your specific needs, monitor the funds you own, and decide when a fund should be sold. Take the time and effort to learn the ins and outs of mutual funds. Financial literacy pays.