Are you getting what you pay for?

Anytime you bring up the word fees with mutual funds; you bring up some controversy. In the current market environment, many investors question the validity of fees. Why pay management fees when you are not making money? Is this question valid? I think so. Will there be changes to the fees in the mutual fund industry? I’m not so sure. Do I have the answers? Absolutely not.

What do higher fees mean to you?

According to Morningstar, Bellcharts data, the average Management Expense Ratio (MER) to the end of July 2003 is 2.59%. The sad concern is that the average MER continues to increase. One year ago when the average MER was 2.406%. Two years ago the average MER was 2.283%. And even one month ago, the average MER was 2.53%. It’s hard to believe that here in Canada; fees are going up while companies are consolidating in hopes of gaining economies of scale.

To provide some perspective, consider that the average MER for what Morningstar calls Before Fee funds is 1.42%. That is 1.17% direct savings. Morningstar considers Before Fee Funds that “report returns before fees rather than the after-all fees presentation of most funds.” Essentially, the difference between the two categories is compensation to financial advisors, brokers, salespeople, and mutual fund dealers.

So maybe the question is “Is your financial advisor worth the fees?” That’s a call you have to make but the perspective I wish to provide is that you do not look at only performance as the benchmark of whether your advisor is worth the fee. Financial advisors can provide value in other ways like financial advice, retirement planning, tax planning, income planning, etc. Does your financial advisor work hard to keep you educated and bring to your attention to new products and new ideas? Are they keeping in touch and helping you manage your portfolio. Take some time to think about whether you are getting the value for your fees. If not, look for another advisor or try to do it yourself.

Saving money on fees

In every industry, consumers can cut corners by taking on more responsibility. For example, travelers can try to save some money by booking flights, hotels and rental cars on their own. Homeowners can try to save on fees by selling their home by owner. Car enthusiasts can try to save a little money by doing their own maintenance on their cars.

In every case, you can save money and sometimes a lot of money. However, saving money means spending more time and having a certain interest and knowledge. So in the end, what is your time worth?

While I think you need to be aware of the fees you are paying, I do not think the cheapest necessarily mean the best. Rather, I choose to believe in a term I call value. Value is the benefit you receive, the less the cost.

The long-term effect on fees

Critics of MERs argue that lower MERS will make a huge difference in long-term performance. Let’s go back and use the difference of 1.17%. Imagine you have a portfolio of $100,000. This means that you will save $1170 in one year on fees alone. If you compound those savings over the course of 10 years, that is over $11,000 of savings of fees.

Remember that fees are only half the equation. Let’s assume the lower MER fund underperforms the higher MER fund by the same 1.17%. Then these funds would deliver the same after fees return to the investor. In the short term, there is little correlation that lower MER funds provide better returns than higher MER funds. However, over the longer term given the regression to the mean phenomenon, MERs will have a greater impact.

My two cents

Fees are important in the sense that any fee you pay takes away from the performance of your investment. It is important that you know how much you are paying in fees. If you are paying more than the average, you should question the value you are getting from higher fees. While there is some correlation that the lower fees you pay the better your long-term returns, don’t get caught up in focussing on fees alone. Evaluating mutual funds goes far deeper than analyzing and comparing MERs.

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