MER – Cheaper is Better

The management expense ratio (MER) is the percentage of your portfolio that you pay to the company that sells you the index fund, exchange traded fund (ETF) or mutual fund that you hold in your portfolio. The fees for these products must be disclosed to potential buyers. Thanks to the wonder that is the internet, you can easily do an online search of any mutual fund, index fund or ETF and find its MER.

Generally speaking, mutual funds are more expensive than both index funds and ETFs. I’m not entirely sure why other than to say that mutual funds are actively managed. This means that there are a whole lot of people who are researching and analyzing data before doing a whole bunch of buying and selling of various stocks for inclusion in the mutual fund. All of those people need to be paid. There’s a lot of overhead that must be covered by fees from clients in order to ensure that all of that activity is performed.

In sharp contrast, index funds and ETFs are passive investments. They simply buy into the top companies that meet their investment objective and then it’s done.

You’ll have to do your own research before you in invest. You can also speak to a fee-only certified financial planner. However, my general advice to most people is the following. If you have the choice of buying a mutual fund or an index fund/ETF, go for the lower cost product so long as you can still achieve your investment goals. It will be cheaper for you in the long run and you’ll wind up with more money in your kitty.

Take a look at the following MER calculator. It allows you to do a side-by-side comparison of the impact of paying a higher MER on your portfolio. You can control so many variables: your investment horizon, the MER, your starting balance, the assumed rate of return, and your contribution amount.

See for yourself…

Start with an investment of $1000 in both Fund A and Fund B. Assume that they are both identical and both of them will help you achieve your long-term financial goals. Commit to contributing $50 per week into your portfolio, which is $2600 per year.

Enter an annual average return of 7% for both funds. And assume that you’re going to be investing this money for 30 years. The average life expectancy is roughly 80 years for humans. Believe me when I tell you that 30 years is not an unreasonably long investment horizon.

Here’s where the steak starts to sizzle. Fund A is a mutual fund charging a measly 1.5% per year. In other words, Fund A skims off 1.5% of the value of whatever’s in your portfolio. Fund B is an index fund, or an ETF, which is charging a minuscule 0.05%. Go ahead – plug those numbers into the formula.

Now, hit the calculate button. What do you see?

Fund A – with the higher MER – is going to cost you $37,330.78 in fees. On the other hand, Fund B – with the much lower MER – is going to cost you $1,244.36.

That’s a difference of $36,086.42 in fees. This is money that is not staying in your investment portfolio since it’s being paid to someone else. Why would you want to pay this amount if you didn’t have to?

Play with this calculator – change the variables – see the impact of higher MERs over a longer period of time. I think you’ll agree with me that when it comes to paying for investment products, the MER matters – cheaper is better.

Hold up, hold up, hold up!

Blue Lobster, are there really investment products that pay 0.05% in MER?

Yes, Gentle Reader, there are. At the time of this post, the website for VanguardCanada is showing two equity products – VCN and VCE – with MERs of 0.05%.

*** To be clear, I am not being paid by Vanguard Canada for mentioning these investment products. I do own units in VCN.

All else being equal, cheaper is better. For simple comparison, the Big Six banks in Canada sell mutual funds that are equivalent to VCN and VCE. At the time of this post, the MERs on their products are much higher than 0.05%.

• BMO
• RBC
• TD
• Scotiabank
• CIBC
• HSBC

I have to amend my earlier statement. At the time of this post, the links for CIBC and HSBC do not disclose the MERs for their equity products. To find the MERs for their products, you will have to do a bit more hunting-and-clicking but you’ll get there. The other 4 banks disclose this information on their website with one-click. This tells me that atleast 4 of the 6 big banks are willing to ensure that their customers can easily find the right information to make an informed choice.

Now you know better.

Paying a higher MER means less money in your pocket at the end of the day.

As a general rule, cheaper is better when it comes to assessing the MER of equivalent investment products. I want to be clear that you shouldn’t base your entire investment decision on the MER. It is a significant factor, but it’s not the only one.

You still have to determine your investment horizon. Is this money for a short-term goal or a long-term goal? If long-term, MER should be given more weight in your decision-making.

Are you comparing equivalent products? An index fund that invests in short-term bonds should not be compared to a mutual fund that specializes in gold and diamonds. The risk profiles of the two products are vastly different. It is reasonable that they would have different MERs so this factor should be given less weight at decision-time.

It is a serious money mistake to pay a higher MER. If you want to really blow your mind, go back and change your starting balance to $10,000 and your annual contribution to $5,200. The disparity in MER cost grows to $83,130.29! And if you extend your investment horizon out to 50 years, then you’re saving yourself $442,979.28! Wouldn’t you rather have that extra money in your portfolio in 30 years? I know I would!

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Weekly Tip: Track all your expenses so you know where you spend every dollar. Despite my constant admonitions to save-and-invest, I know that most people enjoy spending money. However, I want you to be 100% confident that you’re spending your money on things that make your life better. Tracking your expenses is one way to do this. If you see that you’re spending money on things that don’t bring your joy or that make your life worse, stop buying those things. Easy peasy – lemon squeezy!