Sunday, 20 December 2015

Mutual Funds: What Are You Actually Paying?

Mutual Fund Fees

Mutual funds are incredibly popular in the investment world and I'm in no way against their use in a portfolio but it is important that you have an understanding of the various fees involved. The biggies that you need to know about are going to be the sales charges and the management expenses as these will impact what you pay out of pocket and what your return is after the fees are deducted. 

Sales Charges
There are a few different ways you can pay to buy a mutual fund and this will be determined by your plan for the fund and what type of account you'll be holding it in. 

For a front end (FE) or initial sales charge (ISC) fund you will pay your investment advisor commission to purchase the fund for you, usually this will be in the 1% to 5% range. FE funds would be used in accounts where you don't pay your advisor an additional management fee, so really, this is how they get paid. Feel free to negotiate this fee with your advisor but do keep in mind what sort of other work they do for you. If you are getting retirement or tax planning advice at no extra charge then FE funds could very well be where you are paying your advisor. 

Next up are back end or deferred sales charges (DSC) funds and for these you wont pay anything up front for the fund but you will have to pay if you pull your money out of the fund too soon (in the 5-7% range). Usually you have to keep your money in the fund for 5-7 years to avoid the penalty but a lot of companies let you take out 10% of your holding free of charge each year and switch between funds in the same company over that same period. DSC funds tend to get a bad wrap because people don't understand the long term commitment (or haven't been told) and get caught if they need their money. Obviously there are perks for the mutual fund having at least some sort of control over your money for this length of time, so they actually pay your advisor a sort of bonus when you buy these funds. This is where that bad wrap can come into play if your advisor doesn't fully disclose the penalties for early withdrawal to you. 

There are also low load (LL) funds that are right smack in the middle on the first two in that they will charge you to buy them, but usually less than FE (1% to 3%) but will also charge you if you redeem them early but less than DSC (about 3% and they fully mature after only 3 years normally). LL funds have the good and bad of both FE and DSC funds.

Finally there are no load (NL) funds that wont charge you any sales charges to buy or sell...sounds great right? The only hitch is that these are typically used only in fee-based accounts where you would be paying your advisor a commission to manage your accounts (tends to be by entire account or even household and not by each fund individually). 

For most mutual funds you will be able to buy the same fund by any of the above means. For example, you could buy Cdn Bond Fund-DSC, Cdn Bond Fund-FE, Cdn Bond Fund - LL, or Cdn Bond Fund - NL and they will all be the same except for the sales charge you pay (hold the same investments and be managed by the same person). 

Management and/or Operating Expenses
The mutual fund also has certain expenses that they have to pay (salaries, bookkeeping, reporting, etc.) so they pull the cost of these expenses straight out of the funds earnings. This means that you may not have to pay these directly but it still impacts you as it lowers the rate of the return on the fund. 

Most MER's are between 1% and 3% so if your fund has earned a rate of return of 9% for the year you may only see a 7% increase if you're paying an MER of 2%. Included if the MER will also be what is called a trailer fee to your advisor. This tends to be between 0.25% and 1.25% and is kind of like a finders fee for bringing you in as a client for the mutual fund company. 

The MER's aren't transparent to investors and to get that information you need to contact the mutual fund company and even then you'll likely only get a percentage instead of an exact dollar value. It's worth knowing though, especially if you're choosing between two funds that have similar investment profiles; the cheaper one will likely be your best bet. Keep in mind though, portfolio managers with a good track record will cost more but may also make up for it with better returns. As the disclaimer goes though, prior success does not guarantee future returns. 

Another thing to keep in mind when looking at MER's is the type of fund you are buying. More aggressive, actively managed funds will cost you more than a passive fund simply because there will be more trading in riskier markets which means it needs to be more closely managed and is just more work in general. 

That's the gist of the basic fees you will be charged if you're investing in mutual funds. As always, if you have questions or want any additional details feel free to let me know. 

Mutual Fund Fees


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