- In general, the total cost of investing is less known to investors;
- Where investment advice is not fee-based, the costs are embedded inside fund products that investors need to pay attention to disclosures inside fund prospectuses and understand the impact of these costs on their portfolios;
- In a persistently low-growth, low-return environment prevalent today, which is expected to continue in the foreseeable future, every percentage point saving in costs goes a long way in maximizing the value of your portfolio over time (known as the effect of compounding);
- In a report produced by Morningstar in 2013 titled “Global Fund Investor Experience”, Canada has received a scathing “F” grade in the Fees & Expenses Scorecard among 24 countries covered;
- In selecting investment funds to construct a well-diversified portfolio, you should look into the prospect of the fund performing better than its benchmark after all costs. If the track record of the fund over a long period of time (at least over a 5 year period) does not indicate so, you should consider gaining exposure to the desired asset-class through another low cost fund that may simply be tracking the benchmark, such as an index fund or an exchange traded fund.
Mutual Funds and Exchange Traded Funds are common investment vehicles held by investors in their portfolios. However, in our conversations with clients and prospects, we often note that the total cost of investing is less known to many. In fact, many investors believe that so long as they don’t have to write a cheque to their advisor or the fund company beyond the initial investment amount, the rest of any cost elements that might exist, are not significant. In fact, when we explain the Invisor business model to prospects (saying we charge a small fee for the services we provide), a question we often get asked is, “why should I pay you a fee when I don’t have to do so with my current advisor?”
The goal of this 2-part article is to identify and explain the major elements of costs incurred by an investor when investing in fund products. These costs are often not fully transparent (unless the offering documents are properly reviewed in detail), yet they significantly impact portfolio performance over time.
Let me be clear at the outset, Mutual Funds and Exchange Traded Funds, in general, are effective pooled investment vehicles for most investors in constructing a well-diversified portfolio. However, the total costs associated with holding such products should be carefully taken into consideration during the selection process.
Major elements of cost you should pay attention to:
In this post, we will cover the most significant of all expenses – the Management Expense Ratio (MER).
The MER is a measure of the total costs of operating a fund as a percentage of the average total assets of the fund. This is the annual cost an investor bears for investing in the fund. An MER is generally divided into 2 main parts: (i) Management Fee paid to the firm that manages the fund; and (ii) operating expenses incurred by the fund such as record-keeping, fund valuation costs, audit and legal fees, and costs of sending out prospectuses & annual reports. An MER may also include an annual trailing commission paid to the advisor/broker through whom an investor may have purchased the fund to compensate for the advice and planning services provided. The MER also includes the harmonized sales tax in Canada.
The MER incurred by an investor depends on the channel through which the fund is sold to an investor. For example, the report published by the Investment Fund Institute of Canada in 2012 titled “Mutual Fund MERs and Cost to Customer in Canada” indicated that the average cost of ownership of mutual funds purchased through the full service brokerage and the financial advisor channels was 2.27% & 2.38% respectively.
In a report produced by Morningstar in 2013 titled “Global Fund Investor Experience”, Canada received a scathing “F” grade in the Fees & Expenses Scorecard (see below). Explaining why that might be the case is certainly a topic for which I will write a separate article, but most importantly, for now it stresses the importance of paying a lot of attention to the costs of investing, for Canadian investors in particular.
In a following post, we will cover the costs of distribution or sales charges – acquisition costs and disposition costs, which are the other significant components of total costs of investing, which are less understood by most investors. The result is investors end up paying a very hefty fee at the time of entering the fund or at the time of disposing the fund (very common and least understood).
- Know your total costs of owning a portfolio – especially the important elements outlined above. These costs may look immaterial, but they add up and significantly impact your portfolio over time. If you are unclear about the costs and where to find them, consult your advisor, broker or the fund company;
- Although costs are an important component of your portfolio, that is not the ‘be all and end all’ of your investing experience. Constructing a well-diversified portfolio aligned with your goals using the most appropriate funds/securities, risk tolerance and time horizon is of primary importance. In doing so, it is important to strike the right balance between the return objectives and the risks & costs associated with the investment products selected;
- Establishing an investment plan and following a disciplined approach takes emotion out of the equation and maximizes your portfolio value over time;
- Consider working with a fee-based advisor who is independent (not employed by or paid by fund companies) and has access to a wide variety of low-cost investment products with a strong track record, including the F-Series Mutual Funds (only available to fee-based advisors) and exchange traded funds. These products are very effective in constructing well-diversified portfolios seeking to maximize return objectives, while minimizing risks and costs of investing.
Stay tuned for Part 2!
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