Hidden costs can reduce investment returns
The mutual fund industry has been around for over 80 years and continues to be a significant investment option for Canadians. According to statistics by the Investment Fund Institute of Canada (IFIC), Canadians collectively have $926 billion invested in mutual funds.
Unfortunately for this industry, there has been significant criticism of the fees investors are required to pay. Every mutual fund has a Management Expense Ratio (MER). The average MER in Canada is about 2.4 per cent, so that investors need to earn at least two and a half per cent to pay these fees before generating positive returns for themselves. An annual report has given Canadian mutual fund fees a failing grade for three years in a row — they’re some of the highest in the world.
Do you know what your fees are?
I often find investors have no clue what they are paying in fees.
I meet many every year at my workshops and when I ask if they know how much they are paying in fees, typically, in a room of 20 to 50 people, less than a handful say yes. Why is this happening?
Fees embedded
Mutual fund fees are embedded, or hidden. If investors could clearly see the fees being withdrawn monthly, they might be both more aware and more concerned about how high they are. Let’s say you get your mutual fund statement and you see a five-per-cent return. What that statement does not tell you (in most cases) is you might have earned 7.5 per cent if it wasn’t for a 2.5-percent fee that came off the top. Worse yet, if your statement showed a loss of six per cent, that 2.5-per-cent fee still came off. In other words, you would have only lost 3.5 per cent, but the 2.5-per-cent fee increased the loss to six per cent.
So , are mutual funds bad?
These fees may be high, but that doesn’t mean mutual funds are not a viable investment option. They remain an appropriate investment for most Canadians. We just want fees to be lower and more transparent.
That being said, today there are more lower-cost alternatives to mutual funds than ever, including the increasingly popular Exchange Traded Funds (ETFs), which are geared more toward the do-ityourself investor. There are a great deal of opportunities today for doit-yourself investing, but I believe most people still benefit from guidance in this area.
Better disclosure , please
Most Canadians invest in mutual funds because they need help, and their financial advisers, banking representatives or investment professionals have put them into these funds. The fees generally include compensation to these advisers.
I believe advisers deserve to get paid for good advice and services (we can debate what that means in a separate article), but I also think there needs to be better disclosure about how much they get paid, especially when the compensation comes from the sale of products such as mutual funds.
Increased compensation disclosure will help investors understand exactly what benefits they’re getting for the fees they are paying. I would suggest that most investors would be more willing to pay these fees if they had this information.
Th e bottom li ne
The bottom line is lower fees would be better for investors, as they’d increase their returns. In an environment where interest rates are low and stock market returns are modest, high mutual fund fees can really have an impact.
Advisers need to do a better job communicating and disclosing these fees. Right now, the minimum standard is to disclose the fees through the mutual fund prospectus. Yes, that’s that 100-page booklet you got, which nobody reads. Greater fee disclosure will also force advisers to think more about their value proposition and what services they provide for their clients. That being said, investors also need to share in the responsibility and find out more about the fees they are paying. Make sure you ask tough questions about fees and compensation. You would never buy a car, a house, food, clothes, etc. without knowing the price first. So before you buy a mutual fund make sure you understand what price you are paying, how it’s paid and how much the adviser is getting. They are obligated to disclose this information.