Understanding Investment Fees & MERs in Canada
A look into how investment fees and MERs work, in Canada.
Andre DeGagne is the Founder and Managing Director of Calgary based Dentro Financial
Understanding the investment fees, you pay for the advice, financial planning, and the investments themselves is key to choosing the right wealth advisor and getting what you want. There exists a lot of information about this subject, and we wanted to make sure that anyone could understand how this process works and what questions they should be asking their advisor, banker, or broker. Join us as we walk through investment fees in Canada.
Traditionally, most funds use a fee combination known as a Management Expense Ratio (MER). MERs are typically made up of several components, including the management fees, advisory fees, federal taxes paid by the fund company, and operating expenses. There are often additional fees outside the MER that you need to be aware of, including performance fees, trading fees, one-time fees, and federal and provincial sales tax. To truly understand what you are paying in fees, you must take all of these pieces into account and yes, there are a lot of different fees! The total amount you pay in fees is a key factor in how well your investments perform. As your investment fees drop, your net returns rise, and who does not want more money?
Management Expense Fees
The first of the two major pieces that make up an MER is the management expense, which is charged by almost every mutual fund and Exchange Traded Fund (ETF) you can purchase. This fee is mainly used to pay for asset management, portfolio design, and portfolio management. According to Morningstar Inc., the median management fee across all funds is 1.15%.[1] There is, however, a difference in this cost when using an active vs passive approach resulting from the theory behind the investment philosophies. What you need to know is that whether you purchase a fund yourself or from an advisor, this fee is usually the same.
Advisory Investment Fees
The second major component of an MER and easily the most confusing is the advisory fee. This fee is paid to the advisory firm for providing you with several different services that can include selling you the fund, administrative support, and some level of financial planning. Different firms brand this component in different ways. It has been called trailing commissions, trailer fees, brokerage fees, wrap fees, and advisory fees. How companies label this component is not the main problem you should be concerned with, as companies use these different branding options to their advantage, and there are great advisors within every firm type. Instead, you need to ask the following questions: What do I get for this fee? Is this fee included in the MER they are showing me?
First, let us answer what we believe you should get for the advisory fee. Everyone has a different answer to this question, but we believe that the advisory fee should pay for advice and service, not an advisor trying to guess the best stocks or funds to buy. The data says that they are usually wrong anyways! In the personal finance industry, true advice is a full financial plan from a Certified Financial Planner (CFP). By taking all aspects of your financial life into consideration a CFP is able to assess and determine strategies to help your specific situation. Meaning that they do more than just sell investments. A CFP adds value to your plan in many different ways, including tax savings, debt reduction strategies, and helping to prevent you from making big mistakes. If you are paying the average 1.10% advisory fee and all you are getting is a stock picker, we recommend that you revisit if you should pay this fee at all.[2] In this case, you are likely paying over 2.25% a year in investment fees for something you can get for as little as 0.50%.[3] On paper, do-it-yourself solutions are always the cheapest option.
Second, you need to be aware if the advisory fee is being included in the MER or is being added in addition to it. The way this is presented does not make much of a difference as long as it is disclosed and you are made aware of how it is being charged. It is also important to note that this fee often varies based on the size of your investments. We have included a chart of the average advisory fees in the industry broken down by the investments’ size.
Performance Fees
Performance fees are not something that most investors would pay and are not a component of an MER. However, they are often charged by hedge funds and some ETFs, and you should be aware of how they apply to your investments, if at all. A performance fee is a fee charged by the fund for any performance above a given benchmark or high watermark. The most common fee is charged by hedge funds as a component of the famous 2 and 20 formula (2% management fee and a 20% performance fee).
Trading Fees
A trading expense ratio (TER) is what it costs an asset management company to place the trades for your portfolio. Typically, these fees are small and go to the capital markets divisions of financial institutions in Canada. Your total fee includes both the MER and the TER and can be found on a fund facts sheet for any fund in Canada.
One-time Fees
When you buy a fund, there are two one-time fees that you might encounter. The first one is an up-front commission fee. This fee is paid to your advisor upfront and limits how much you get to invest. For example, if you pay a 2% front-end commission fee on a $100,000 investment, you only have $98,000 left to invest. This means that you have to recover $2,000 before you start to earn any net investment returns. It is also important to note that these fees are very rare in Canada.
The second one-time fee to be aware of is a back-end fee, also known as a deferred sales charge (DSC). These fees are triggered if the fund is sold within a certain time frame, often between three and seven years from the time of purchase. They are also often quite expensive and can be as high as 5.0% of assets.[4] The up-side to these funds is typically a small discount to your MER. Both of these fees are charged in addition to the MER you pay and are only currently used by a few companies in Canada including Primerica, World Financial Group, and CI Investments. Most other companies have stopped selling DSC fees.
Putting it All Together
Again, we cannot reiterate how important it is to have a good understanding of the investment fees and MERs you pay. Now that you are aware of all the pieces, we want to take a look at how they come together for the majority of Canadians. Below you can see a breakdown of a typical MER.
If we assign the fees to all of the pieces that we have discussed, you can see that the total average investment fee in Canada is between 2.35% and 2.00%.
We hope that this article has helped you get a better understanding of the landscape in Canada and provided you with some important questions to ask your financial advisor.
We are helping people take control of their finances and reach their financial goals, one day at a time. You can learn more about Dentro Financial at dentrofinancial.com.
