In response to a long-running debate on the merits of the Smith Manoeuvre, a financial planner made the following comment:

The best portfolio is a diversified portfolio, MER be damned.

What is MER?

The MER of a mutual fund or exchange-traded fund (ETF) refers to its Management Expense Ratio. It is calculated by adding up the management fees paid to portfolio manager, the trailer fees paid to your investment advisor, administration charges incurred in running a fund and GST/HST and dividing the total by the average value of assets in the fund and reported as a percentage.

For example, consider the XYZ High Fee Fund, which reported a MER of 3%. If the fund had an average of $100 million in assets, the MER implies that the fund cost investors in $3 million (3 percent of $100 million) in fees.

How is MER charged?

If you are a mutual fund (or ETF) investor, you do not pay MER directly to the fund manager. Instead, the fund manager deducts the MER from the mutual fund. In the example of the XYZ High Fee Fund, which has holdings totaling $100 million, the manager will effectively deduct $8,219 ($100 million x 3 percent รท 365 ) every day.

Notes on MERs

There are two items of note when it comes to MERs. First, MERs may be the biggest fees incurred by most investors but it is not the only one. Trading fees, for example, are not included in the MER but, nonetheless, it is a cost to the investor. Second, returns advertised or reported by mutual funds are always net of MERs. If XYZ High Fee Fund reports One Year returns of 5 percent, it means that an investor in the fund would have earned 5 percent over the previous year after indirectly paying all the fund’s expenses including MER and trading commissions.

Is MER important?

While the returns advertised by mutual funds already account for the MER, investors should still pay attention to how much fees they are paying because a higher MER does not mean a better product. In fact, many studies have demonstrated the opposite: the lower a fund’s fee, the better its odds of posting future returns that are better than average. As John Bogle likes to say: “in mutual funds you don’t get what you pay for. You get what you don’t pay for”.

The next time you are investing in a mutual fund, picking the one with the cheapest MER in its class will increase your odds of success. Better yet, you could simply pick the cheapest index fund.

This article has 10 comments

  1. My father used to tell me, “if you’re going to do something, do it right.” I find it hard to believe that someone will take on the leverage risk and all the extra work of the SM for the sole purpose of tax breaks, they’re doing it to maximize their net worth, and that also involves watching the pennies on the investment side.

    That said, I too am an incorrigible skeptic :) Or at least emotionally unprepared to ever do it myself. I’d prefer to plan sooner to achieve my goals than add risk and leverage.

  2. The best portfolio is a diversified portfolio, MER be damned.

    This is the stupidest comment I’ve ever heard. Is he saying that you can’t have a diversified portfolio without high MERs? Or is he really saying “I’m maximizing my compensation at your expense but don’t worry about it”.

    I would fire this guy if he was my FA.

    I put a much longer SM rant on the comments section of that blog.

  3. Steve: I am not planning on implementing the SM either and I am very wary of leveraged investing in the stock market. Buffett is fond of saying that “the markets can stay irrational longer than you can stay solvent” and I hope investors are aware of what they are doing.

    Mike: Of course, there is a bit of self-interest involved in claiming that MERs don’t matter. If future equity returns trail that of bonds, people who implemented the SM would wish they’d never heard of it.

  4. Canadian Capitalist

    I just got my copy of this month’s MoneySense magazine and in page 15, there is a column titled – “Pay less, get more”. The author, Duncan Hood, cites research in the US and Canada and says:

    “For every percentage point your fund company charges you in fees, your return goes down by one percentage point”.

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  6. The remark on MER be damned, diversified portfolio matters is not that idiotic when taken in the right context. Sure, all else being equal, every .1% in average portfolio MER drags down returns. However, I think the original poster’s point could be taken in a positive light as saying “if you are trying to put together a portfolio that needs to beat not 0% but 4% (the post-tax hurdle if you have a 6% HELOC), it is doubly important that you have a well-diversified portfolio of investments to minimize the volatility. Getting this diversification can be worth buying a higher-MER investment to make it be more optimal. Furthermore, if you have limited time to dedicate to finding the optimal investments, you will do better to pay a higher MER and spend your time creating a balanced portfolio than chasing the lowest MER but not thinking through risk diversification”. That’s a longer statement, and more nuances, but I think (I hope) that’s what the poster had in mind.

  7. There is a real structural issues about fees in the Canadian context that I am discovering. See http://www.thickenmywallet.com for details. It ain’t pretty that’s for sure.

  8. Every point they make, you lose, it’s a zero sum game, they either give you the money, or they take it themselves.

    Anybody who wants you to take a high MER mutual fund, must have invested in the Funds Parent company or gets a commision from them (mostly).

    ‘Nuff said –C8j

  9. Canadian Capitalist

    Houska: A diversified portfolio and low-costs are both important. You can’t ignore either of them and hope to be a successful investor.

    There is no research backing up the claim that MERs don’t matter and buying a high-MER fund is almost always a bad deal.

  10. could someone explain to me the importance of mutual funds to investors and its classification, and benefits mutual funds offer to investors please.

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