If you are appalled at the exorbitant cost of investment fees in Canada and the toll it takes on returns, you’re not alone.
A Morningstar report showed that Canada had a D- score when it comes to fees and expenses, bottoming out in a comparison among 25 different countries. Essentially, what this means is that we pay the highest investment fees when compared to the rest of the developed world.
Of course, the reality of banks behaving badly is not new or rare in Canada. In 2016, we heard about CIBC paying more than $73 million back to clients to compensate them for “inadvertently overcharged fees.” In 2017, it was RBC’s turn to repay $21.8 million to clients who had been overcharged as well. These are just a few of many instances when banks ‘inadvertently’ gouge their clients for more fees than they should be paying.
It appears that the government may be starting to get concerned too. Regulators in the financial industry deserve some credit with recent regulation – the Client Relationship Model Version 2 – requiring greater transparency in the reporting and disclosures of investment performance and fees by investment firms.
This is a step in the right direction as a lot of investors are oblivious to the fact they are paying a lot in fees due to the way these fees are embedded or cloaked inside of other financial mumbo-jumbo. It is a good starting point, but more needs to be done.
What Investment Fees Are You Paying?
The average management expense ratio (MER) you can expect to pay in Canada for equity mutual funds is 2.35%. To put this in perspective, if you have an investment portfolio of $100,000, you could be losing about $2,350 to fees every year on average! Compare that to an average of 0.84% for similar funds in the U.S., and it almost makes you want to go ballistic.
The MER is just one of the many fees you may have to pay on your investment portfolio. There are several other fees that may accrue depending on what type of investment you buy, where you buy it, your account balance, and many other factors. Many of these fees were carefully ‘hidden’ until recently.
1. Management Expense Ratio (MER)
This forms the bulk of the fees you pay when you invest in mutual funds. MER is an annual fee charged to your portfolio and consists of a mix of management fees, operating expenses, and trailing commissions. To find out what the cost of MER is for any particular mutual fund or Exchange Traded Fund (ETF), look closely at the funds ‘Fund Facts’ or prospectus. For example, RBC’s Balanced Fund Sr A has a MER of 2.16%.
MER costs are paid directly from the fund and will lower total investment returns over time. The more active the strategy adopted by a fund manager is, the higher the MER will be. MER is charged whether or not a fund performs well. The return earned on your portfolio is reported net of the MER.
In general, MER fees will go to pay investment managers, legal and other professional fees, administrative fees, marketing costs, trailing commissions, taxes, etc. If you’re interested in how the MER is calculated, it is ⇒
MER = Annual Fees + Annual Expenses / Net Assets
2. Sales Commissions (Sales Loads)
These are commissions you pay to investment dealers when you buy or sell a fund from them. These sales loads come in different forms:
a. Front-end Load (Initial Sales Charge)
An initial sales charge may be charged by the investment firm selling you the fund. The cost can be up to 5% of your initial investment and the money goes to the financial advisor’s firm. The fee charged may be negotiable.
For example, on a $10,000 initial investment, if you are paying a front-end load of 2%, then $9,800 is invested in the fund, while $200 is paid to the advisor’s firm. Front-end loads are now less common due to the increasing competitiveness of the investment landscape.
b. Back-end Load (Deferred Sales Charge)
Some funds charge a deferred sales charge which infers that they pay the advisor’s firm a commission out of their own pocket when you initially buy into the fund. Depending on how long you hold the fund, when you eventually sell it, they may charge you a fee that is up to 7% of your portfolio.
The longer you hold the fund, the less you’re charged in fees. If you hold the fund long enough (usually 5-7 years or longer), this fee drops to 0%. On a $10,000 fund investment, a 7% deferred sales charge is $700 down the drain.
c. Low-load Sales Charge
With front-load and back-load fees going out of fashion, some firms now use the low-load fee approach. With the low-load deferred sales charge, you are not charged a commission upfront, and if you hold your investment for longer than 2 years, no fees are charged if you redeem or sell your investment. Charges for redemption within the first two years are also much lower, typically around 2%.
Not all mutual funds charge fees for buying and selling their funds. There are numerous No-Load mutual funds out there that do not require you to pay a commission.
3. Trailing Commissions (Trailer Fees)
Although these are usually embedded in the MER, they warrant a separate definition. They refer to ongoing commissions paid annually by an investment firm to financial advisors for their services. It can account for up to one-percentage point or more of the MER.
On a $10,000 mutual fund investment with a 1% trailing commission, you would be leaking $100 or more per year in trailer fees.
4. Short-term Trading Fee
This is usually applied if you switch out or redeem a fund within 30 days of buying it. Investment firms levy this fee (1-2%) in order to discourage short-term trading.
5. There are several other investment fees you will encounter out there. For registered accounts (RRSP, TFSA, RRIFS, etc.), you may have to pay fixed fees for administration, deregistration (full or partial), unscheduled withdrawals (RRIF), and for transferring your assets to another institution.
Options to Lower Investment Costs
A. Go With Lower-Cost Options: Canadians now have more options when it comes to what they can invest in and how they can do so.
- Exchange Traded Funds (ETFs): These come with much lower MERs (as low as 0.06% – Yes, you read that right!) e.g. Vanguard FTSE Canada All Cap Index ETF and iShares Core S&P/TSX Capped Composite Index ETF. A mutual fund with similar holdings can easily have a MER of 1.8% or more. For a $100,000 investment portfolio, the ETF (at 0.06%) will cost $60 in annual MER, while a mutual fund (at 1.82%) will cost $1,820. Note, however, that ETFs generally come with a fee per trade which can add up and become significant if you are trading often in a small portfolio.
- Index Funds: Index investing has become very popular since when they were first advocated by John Bogle (author of “Common Sense on Mutual Funds” and founder of The Vanguard Group). These funds work very well for investors with smaller accounts (under $50,000) since you do not have to pay transaction fees per trade and can easily make small regular purchases. Index funds also usually come with much lower MERs compared to traditional mutual funds. This is because they are passively managed. Examples of popular index funds include: TD e-Series Funds (such as TD Canadian Index e-Series (MER 0.33%)), Tangerine Investment funds, RBC Canadian Index Fund (MER 0.72%), etc.
- No-Load Mutual Funds: as mentioned earlier, there are several no-load funds available in the market today. Additionally, you can also look at mutual fund companies that have superior performance coupled with lower MERs when compared to their peers. Examples include: Mawer and Leith Wheeler.
B. Trade Less Often: If you go with the Do-It-Yourself ETF investing option, you can save a lot in MER fees. However, it becomes counter productive if you start trading a small account frequently as the $9.99 + transaction fees quickly add up. Consolidate your trades. Larger accounts may also qualify for commission-free trading (buy-side for select ETFs) on some discount brokerage firms including: Questrade, Qtrade, and Virtual Brokers.
C. Use Low-Cost Management and Advice: Robo-advisors are getting popular in Canada. They are significantly cheaper than full-service financial/traditional advisors and are accessible via an online platform. Additionally, you don’t need to have a large portfolio in order to utilize their services. Examples of these online financial advisor services include: WealthSimple, Nest Wealth, WealthBar, MordernAdvisor, and Invisor. For an in-depth take on Robo Advisors, check out Young and Thrifty’s Complete Guide here.
D. Get Someone Else to Pay the Fees: If you are moving your investment account to another financial institution and have to pay a transfer fee, ask the receiving institution if they are willing to pay the fee on your behalf. In most cases, if you are bringing a substantial account, they will be willing to do so.
Are Investment Fees All Bad?
No. The better question is: “what value are you getting for the fees you’re paying?”
I could just as easily title this section: ‘Investment Performance and Pursuit of the Holy Grail.’ If you are getting more bang for your buck compared to a similar fund with lower fees, then the fees you are paying may be worth it. If not, you should probably start looking for cheaper (and better) alternatives since you’re losing money.
Generally though, the data is not sufficiently favourable enough to show that there’s a significant leverage to be had by paying excessive MER’s to active equity fund managers – based on how they perform relative to their benchmark index.
The financial market is a beast that cannot be fully tamed. It’s volatile, and will rise and wane outside of your control. For longer term success in the markets, significantly cutting down your costs may be the key!
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