Friday, 30 October 2015

Mutual funds Fees

Since this is my first blog post.  My first topic will be Mutual Funds, in particular the M.E.R. or management expense ratio.  For most Canadians, the core saving vehicle will be the Mutual Fund in a RRSP.  You setup pre authorized deductions of whatever amount you want.  $100, $200 a month.  Sound familiar.  You then have a setup meeting at the bank are also asked about your risk tolerance, your time horizon, if your portfolio loses 10%, will that make you mad?  Basically a questionnaire.  You are then asked to pick your allocation for your automatic withdraw every month.  30% to Canadian Equity, 30% to Fixed income, 20% to U.S. Equity, 10% to European equity, 10% to Energy stocks.  Sound familiar?  Then you have that $200 deducted every month and allocated accordingly.  You get a tax receipt at the end of the year.  You file your income tax return and get a refund back.  All is well, you get quarterly statements of your funds going up or down.  If this setup sounds familiar, read on.  This monthly deduction thing goes on for 5 years? 10 years? 15 years?  Its not uncommon for it go on longer, meanwhile you keep pumping in those monthly contributions.

Now I don't know about you but in my meeting, they never mentioned to me how much all this was going to cost?  They just said, pick your amount, pick your percentage.  I was shown the 1 page profile of each fund, which showed the MER.  A percentage, usually higher with more aggressive funds.  But never mentioned the cost.  So how do they get paid, they get paid from your fund that's how.  Yes I will explain.  Here come the examples.  If I invested $1,000 into 10 different companies and bought 1 stock in each company and lets say they were all $100.  My balance on my statement would say $1,000.  I would have to pay commissions to buy but that would be a one time expense.  I then hold the stocks for 20 years, never have to pay again.  The value goes up, goes down.  The only other time I have to pay is when I decide to sell the stock which makes it a 2 time expense which is usually around $10 or under.  Now what I just described was a kinda of mini mutual fund.  Now let's do the same idea but with a mutual fund.  For argument purposes, the mutual fund will buy the same 10 stocks (I know, most mutual funds have over 100 holdings but we will compare apples to apples).  You invest the same $1,000 into the fund, you get units in the fund, something like 100 units at $10 to equal $1,000.  So how do they get paid?  your balance is $1,000 on both examples?  Are you ready for this?  The mutual fund will give a price for their units and this reflects their cut or MER.  What are you talking about Peter, my balance for my mutual fund is $1,000.  An example would be best here.  You give me $1,000 for 10 chairs.  I say ok.  The chairs have a value of $980 when I buy them for you.  I give you a statement that says the chairs are worth $1,000.  I keep the $20 as my fee.  The 2% MER is working its magic.  So basically every $100 I put into the funds, I was behind 2% right off the bat because the 2% comes off whether the fund goes up or down.  They say the MER is for professional management of the fund.  I have noticed that most funds have 180 holdings or more.  Very small percentage of holdings.  There will be top 10 holdings of each fund on the 1 page profile sheet.  When the top 10 moves up or down, the fund price goes up and down.  So basically you are buying the top 10 holdings.  Why can't I copy and buy only the top 10 holdings of certain mutual funds?  If it's good enough for the professional manager, why not just for me?  The answer is you can't do that at the branch level but they don't say that at branch level, they never give you the option.  You will need a discount broker.  Which will be a different blog post.  This post is all about MERs.

Let's shock you a little now.  Jump ahead 20 years, you started saving those monthly deductions at age 25 so now you are 45 and just for argument sake, you had a decent job, and put in more than $200 a month.  Your portfolio shows a balance of $500,000 at age 45.  Very possible. The average mutual fund MER currently is 2.1% sounds like a small number doesn't it?  Well they shave off that 2.1% at a tune of $10,500 a year.  yes there is that $20 shave from earlier is now a bigger shave of $10,500 a year.  The problem with this shave is that the average person in the street does not even know this even exists.  If you keep your money in mutual funds for 10 years, you are giving up MER fees at a tune of $100,500 for those years.  This does not take into account compounding.  Thats a lot of fees,  the first time i did this calculation, I had to do it 3 times, there is no way I am giving over $100,000 in fees.  Now think 20 years instead of 10 years, that would be over $200,000 in fees.  You saved hard for so long and you give this much up in life savings?  Does that hurt yet?  It angered me once I discovered this setup.  I worked hard and some fund manager whom I have never met is getting bonuses on managing the fund?

If you run into a person who says has a portfolio of this size or close to it.  Ask them about how much their fees are?  See what their answer will be.

That is my take on mutual fund MERs, their setup, the almost no discussion of it by the bank, the advertising of mutual funds for your RRSP at the bank, the no advertising of discount brokerage at most banks, and the amount fees for holding a lifetime of mutual funds.  I won't go out completely and say all mutual funds are bad, there are good ones out there but the just the non existent discussion of fees should open eyes, especially to the everyday person.  What can I do about this Peter?  Is there an alternative?  No one has ever presented me with an alternative?  I still want to save?

Next blog.........My switch out of Mutual Funds.