Mutual Fund Fees: The High Cost Of Canadian Funds
Mutual funds are a popular choice for Canadians, especially for those who are just learning how to invest. They are easy to set-up at your local bank, and with as little as $25 or $50 a month investors can open a pre-authorized purchase plan to get them started.
Unfortunately, it is widely reported that mutual fund fees in Canada are the highest in the world. According to this 2009 study by Morningstar, Canada has notoriously high management expense ratios. Let’s take a closer look at the different types of mutual fund fees:
Management Expense Ratio (MER):
All mutual funds have a management expense ratio (MER), which is the day-to-day expense of operating the fund. The ratio is calculated by taking the fund’s operation expenses and dividing by the average dollar value of its managed assets.
The MER consists of fees paid to the fund manager, as well as accounting, marketing, legal and administrative costs. Canadian MER’s contain trailer fees, which are fees fairly specific to the Canadian market. Trailer fees cover the expenses and commissions for the professional advisor.
According to the Morningstar study:
- The typical investor in a Canadian fixed income fund pays a MER of between 1.25% and 1.49%.
- The typical investor in a Canadian money market fund pays a MER of between 0.40% and 0.89%.
- The typical investor in a Canadian equity fund pays a MER of between 2.00% and 2.50%.
As if mutual fund fees weren’t high enough in Canada the MER’s don’t even include sales commissions that investors may be subject to when buying or selling mutual funds.
Front-End Loads:
This is a sales commission charged to the investor when they purchase a mutual fund. Front-end loads reduce the amount of your investment, meaning that if you invest $1,000 into a mutual fund with a 5% front-end load, $50 will come off the top of your initial investment and only $950 will be invested in the fund.
The typical maximum front-end load for a Canadian mutual fund is 5%. All front-end loads are negotiable between the investor and the advisor. The typical Canadian investor pays a front-end load between 4% and 5%, primarily because investors are unaware that this fee is negotiable.
Deferred Sales Charges:
This is a sales commission charged to the investor when shares of a mutual fund are sold. The financial advisor is actually paid the commission up-front, but it does not get subtracted from your initial investment. Instead, the fund charges an early redemption fee if the investor sells the funds within seven years. The redemption fee typically starts at 5% in the first year and then gradually declines until it reaches 0% after seven years.
No Load Funds:
No load funds are just as they sound, there is no up-front commission paid to the advisor, and there is no deferred sales charge upon selling the funds. The only mutual fund fees that investors will need to pay with a no load fund is the management expense ratio.
The advisor will still be compensated with an ongoing annual trailer fee as long as you hold the fund. The trailer fee is 1% but, as discussed earlier, is included in the MER of the fund.
Understanding Mutual Fund Fees:
Although mutual funds are extremely popular in Canada, investors need to do a better job understanding the high mutual fund fees that they are paying.
According to the Morningstar study; Canadian investors do not pay much attention to fees. Canadian investors are comfortable with the fees because they don’t know how low these fees should actually be. Assets tend to flow into higher-fee mutual funds because Canadian investors use financial advisors to help them make decisions. Advisors direct client assets to funds that pay better trailers. And since the trailer is included in the MER, the result is that assets flow into higher-fee funds.
Mutual funds are a great place for investors to get started, but not if Canada continues to have the highest mutual fund fees in the world. Don’t let your portfolio get eaten away by unnecessary fees. Shop around for cheaper funds, or look into ETF’s as a low-cost alternative.
Good article. There are so many problems with the current status of the financial industry. Fees are just one. Even when investors DO question fund fees, advisors’ responses can be, at best, obfuscatory. The industry needs a shake-up, just not at the expense of the individual investor.
Isn’t the simple solution, lower MER ETFs?
Until investors wake up and drive change,there will be none.
I, after much research, am, as I type, moving my investments out away from a large investment firm and into lower fee investments while changing advisors.
Got Index Funds?
Great post!
This is exactly the reason why I left mutual funds over 10 years ago and have never looked back since.
I guess you want to be an investment adviser were you can benefit from the high fees. It’s where the least risk is, and if the market tanks you aren’t the one that loses on an investment. I stay away from mutual funds, but I know of people that have both made and lost money investing in them.
As a licensed Portfolio Manager and insider of the industry, I was very pleased to read that the Canadian government is finally starting to tackle the unethical practice of hidden mutual fund fees.
It is quite incredible to think that the government allows this practice whereas other western countries like the UK, Australia and the US require the disclosure of all fee costs to the clients. In Canada, hard working, honest, unsuspecting investors put their faith with their mutual fund advisor not understanding the out-of-pocket costs at all.
Recently, I performed an audit for friends of mine. Both are smart, successful entrepreneurs. One is even a financial savvy accountant. They had absolutely no idea that they were paying $31,000 in fees a year on their million dollar portfolio. Moreover, their bank advisor had sold them the funds with a deferred sales charge which is another black mark / scam in my opinion.
Unfortunately, most people are unaware that mutual fund salespeople do not owe a fiduciary duty to their clients. This means these salespeople are not legally required to act in the best interest of the client. Aye, there’s the rub — there is a huge conflict of interest as advisors make the most money for themselves by placing clients in high expense mutual funds that pay the most in hidden trailer fees.
For now, we can only hope this issue gains more traction. Having high mutual funds fees provides absolutely no social benefit to our community. It simply is a way of siphoning money out of the hands of good, honest Canadians.
Jeff Kaminker
President, Fronwater Capital
@Jeff – Thanks for your comments. I agree, there needs to be some intervention made to put a stop to these practices. Investing in mutual funds should be a great way for people to build their portfolio through regular purchase plans, but not at the cost of 2 – 3% in annual fees.
Fees are too high in Canada, but until investors start voting with their wallets and STOP investing in high fee funds there will be no incentive for the industry to change.
Definitely more financial education would help, they should make it part of mandatory curriculum in high-school.
Legislative changes to put the actuall dollar amount of fees charged to a client on the quarterly and annual statements would also be beneficial to further the process. Full and true and plain disclosure of the fees on every statement, in dollars and percentages for people who are mathematically challenged. Sometimes 2% sounds small but on a quarter million portfolio that is 5,000 per year and someone seeing a line item that reads “ANNUAL FEE FIVE THOUSAND DOLLARS” is going to start asking questions about saving some of that expense.
Hi Carl, I agree with disclosing the actual dollar amount of the fees you’re paying.
I just read about this high income physician on Canadian Money Forum – http://canadianmoneyforum.com/showthread.php/11754-Need-your-advice – and he was absolutely taken advantage of by his “advisor”, who put his money in all kinds of high MER products. Sickening.
“The typical Canadian investor pays a front-end load between 4% and 5%, primarily because investors are unaware that this fee is negotiable.” You cannot be any further from the truth. Advisors typically waive the front end fee. Very rarely do advisors charge the front-end fee. I work in fund operations at a major broker dealer and I see daily transactions. The study conducted by Morningstar made the same mistake you did, That’s why Canada scores poorly in terms of fees.
When is the new law mandating so-called ‘financial advisors’ taking effect? And are insurance ‘salespeople’ who sold me high cost Seg Funds included in this disclosure group?