If you’re a DIY investor (or taking steps to become one), you’ve like come across the term MER when researching potential ETF and mutual fund picks. MER stands for Management Expense Ratio and is a yearly fee charged for holding an investment fund – completely separate from brokerage and commission fees – and can have a significant impact on your portfolio returns.
Not exactly sure how MER fees are calculated or what they pay for? We break down the facts below.
What is MER?
The Management Expense Ratio (MER) is a yearly fee associated with buying and holding an individual investment fund. MER is expressed as a percentage of your average portfolio’s value, hence the term “ratio”. For example, if you have $10,000 invested in a particular fund with a 1% MER, you will pay $100 in MER fees that year.
You should know that MER fees are not deducted from your account as a fee. That means that you’ll never see it show up in your transaction history or on any statement. Instead, it is excised from the average annual value of the fund, meaning that it’s directly taken out of the returns. That’s another reason to pay attention before you invest in the fund and to check the MER regularly while you’re invested in a fund (MERs can change from year to year). It’s pretty easy to completely forget that you’re even paying it.
What is included in MER?
The MER is typically the total cost associated with the management and operating expense of the investment fund, including the salaries of the fund managers, legal fees, sales taxes, and almost everything involved with running the fund.
You will often see both a Management Fee and an MER in a fund’s documentation or factsheet. The Management Fee, which is the fee paid to fund managers for performing investing duties (kind of like a salary or commission) is part of the MER, so MER is a more holistic and overall better metric if you want to know the overall cost you’ll pay for the fund or to the advisor.
What is not included in MER?
There are some other costs that you can incur while investing that are not included in the MER:
- Trade commissions to the broker are not included in the MER.
- If you invest in a fund in another currency, you will also be charged with foreign conversion fees.
- Depending on the type of account you use to invest in a given fund, you may owe taxes on the capital gains and/or dividends.
What is a good MER?
Canada has historically had some of the highest MERs across developed countries, with some mutual funds charging between 2% and 2.5%.
Thankfully, cheaper options than mutual funds have become available. Robo-advisors typically charge about 0.5%. If you go the DIY route, and invest in index funds through an online discount brokerage, you could pay less than 0.2% in MER fees depending on the ETFs you choose.
Why are MERs important?
You should pay attention to a fund’s MER because these fees can slowly eat away at your profits. If we go back to the example of $10,000 at 1% MER, it seems like $100 is not that much. However, MER is calculated as a percentage of your portfolio, and your portfolio will (hopefully) be growing with time. If your goal is to save $1 million for retirement, a fund with a 1% MER will mean you’ll be paying close to $10,000 per year as you get close to your goal.
Let’s compare a typical Canadian mutual fund to a DIY ETF portfolio with the same performance (7% annual return). In this scenario, we assume that you invest $5,000 per year, and reinvest the interest, for 40 years. With the average mutual fund (2.35% in MER), your portfolio would amount to $549,000 after 40 years while your DIY ETF portfolio (0.14% MER) would be worth $1,029,000.
When you pay high fees, not only do you lose the fee money, you also lose on the compounded interest that you could have made by reinvesting the fee. Of course, this is just an example, but if you want to calculate how much of your investments’ returns you’re actually keeping, you can calculate your T-Rex score, a metric that Larry Bates came up with to help Canadians retire better.
How to minimize investment fees?
The cheapest option in terms of MER is to passively invest in a few selected ETFs. Some ETFs have MERs as low as 0.02%, and there are now all-in-one ETFs, such as VGRO or VBAL, that act a lot like mutual funds but for a fraction of the cost (about 0.2% MER). If you’re looking for inspiration, the Canadian Couch Potato blog has model portfolios that you can use to get started on the DIY investing journey.
Other than looking for the cheapest MER for comparable investment products, there are a few things that you can control to minimize how much your investments cost you as a whole.
Look for a brokerage with commission-free trading. Most discount brokerages have free ETF buys so you can build a passive portfolio without paying any trading commission. To avoid conversion fees, the obvious way is to invest in assets traded in your currency, although you may not be able to find apple-to-apple for all investment products.
Optimizing your taxes is a bit trickier because it depends on various factors, such as the type of asset you hold, from what country the asset originates, and in what type of account you hold it.
The first easy thing you can do is use up your contribution room in your registered accounts (RRSP, RESP, TFSA) before you start investing in taxable accounts. Note that RRSP and RESP accounts are tax-deferred, meaning that you don’t pay taxes on the capital gains while the money is in the account, but you pay taxes when you withdraw cash from the account, while TFSA accounts are tax-free.
MER is the management cost of an investment fund. Since it is calculated as a percentage of a growing portfolio, it is an important factor to consider when you start investing, as it can slowly but surely diminish your returns.