You can save more on fees than on Black Friday

Shoppers flock to Black Friday sales to save hundreds of dollars on electronics and other items, but there is a place where most Canadians can easily save thousands of dollars per year and yet are doing little about it.

We’re talking, of course, about the costs associated with managing their investment portfolio.

Unfortunately, the fee structure among many Canadian mutual funds can be quite convoluted and overly complex, with a lot of the fees buried within a lengthy marketing document or prospectus.

There are MERs, front-end loads, back-end loads, deferred sales charges and trailers. Do you honestly know what each is? If not, you are in good company, as most Canadians are unaware of how much they pay to have their money managed.

To simplify matters, an investor essentially has three typical options when buying a Canadian mutual fund.

Option one is a Class A fund unit with a front-end load. This means the investor will pay a negotiated front-end sales commission of up to 5% directly to an advisor. The proceeds (less this upfront sales charge) are then used to purchase units in the fund, which then charges an ongoing fee to the manager of the mutual fund ranging from 2% to 3% per year. This is otherwise known as the management expense ratio (MER).

This management fee is embedded within the fund and will be deducted from the value of your units. Many also do not realize the fund manager shares this fee with the advisor via an annual load, otherwise known as a deferred sales charge (DSC). Here, the fund company pays the advisor an upfront commission of up to 5% of the value purchased and an ongoing trailer ranging from 0.5% to 1% per year.

However, this means there

Eliminating the upfront mutual fund load of 5% could save an investor a whopping $25,000

trailer fee commission that often amounts to 1% or roughly half of the total management fee collected.

Option two is a Class A fund unit with a back-end will be a DSC, which is a penalty the investor has to pay if he redeems or sells the fund early. The mutual fund company charges this fee so it can recoup the upfront commission it paid directly to the advisor. This penalty declines the longer you hold the fund, from 5% to zero at the end of year five or six.

Option three is a Class F fund unit and doesn’t have upfront or back-end sales charges or embedded trailers. An investor simply pays the ongoing management fee that can range from 1% to 2% per year and the advisor charges an incremental flat fee outside of the fund, often ranging between 1% to 2%.

We believe this third option is best for investors, because it removes the conflict that comes with funds that pay an attractive sales commission and it has lower total fees.

The second-best option would be Class A with a zero front-end fee followed by the Class A with something called a low-load or low deferred sales commission charge. This means the sales charge schedule is shorter with lesser back-end penalties along with a lower trailer fee.

By doing a little homework, there is no reason an investor can’t shave off at least 1% in excessive fees per year. On a $500,000 portfolio, that translates into $5,000 a year in savings. Eliminating the upfront sales charge of 5% saves the same investor a whopping $25,000.

A good fee-based advisor provides a lot of value, but the average investor should pay no more than 1.5% to 1.75% in total annual fees and a high net-worth investor no more than 1% for such services, as we think that adequately compensates both the advisor and the fund manager.