Here’s a question I received recently.

“We would like to know what it costs for your services.  We believe you work on a % basis but before we request your service we would like to know what you charge for your services.”

Excellent question! You don’t pay me anything directly. When you invest in mutual funds, compensation for whoever is advising you is built into the management fees. With GICs, the interest rate is set at a level which allows the provider to compensate the broker. In the same way, funds and GICs sold through bank networks include fees to pay overhead and salaries. You may not feel that you are paying anything, because the compensation for everyone working on your behalf is embedded in the structure of the product. The same goes for insurance products.

With mutual funds, all the expenses of the fund are disclosed in the prospectus, which is a document given to you when you invest. What you look for is called a Management Expense Ratio, or MER. This cost may be 1.8% for a bond fund, or 2.5% for an equity fund (a fund that invests in stocks). To simplify a bit, a 2.5% equity fund MER typically pays 1% to the management company that makes the decisions about which stocks to buy or sell, 1% to the investment dealer (HollisWealth, TD, Investors Group, etc.) and .5% for miscellaneous expenses (transaction fees on trades, audit fees, custodial fees, customer service, printing, regulatory fees, etc.)

So if your mutual fund reports that it earned you 10% last year, it actually earned 12.5% but after fees your statement will show that it went up 10%. If the fund reports that it went down 10%, it actually went down only 7.5% but after fees your statement will show a 10% decrease in value. The size of the MER is a factor when I choose a fund for clients, but only one of many. I look for managers who have a long history of outperforming their benchmark index after fees. I would rather have a manager who earned 10% for my client with a 2.5% MER than one who earned 8% with a 2.2% MER. That being said, if two funds have similar risk characteristics, management style and performance, I will tend to choose the one with lower management fees.

The situation changes as your portfolio grows. When the value of household investments exceeds $150,000 we start to look at ‘high-net-worth’ solutions. A portion of the management fees you pay becomes visible and is deducted from your account each month. This fee may be 1/12% of the value of your investments (1% annually), and it allows you to invest in high-net-worth versions of mutual funds that have lower management fees, as well as other low-cost investments. The overall cost (the 1% paid to your investment dealer plus any embedded costs) may be 10-15% lower than traditional mutual funds. As well, the 1% becomes tax deductible for non-registered accounts. When your portfolio gets to be over $1M, there are further decreases in costs.

To summarize, mutual fund investors pay (directly or indirectly) .5% to 1% of their invested assets to their investment dealer, and your advisor gets a portion of that. You also pay 1% or so to the managers who manage your funds, and a smaller amount for miscellaneous costs. As the size of your portfolio grows, your costs of management grow, but typically become a smaller percentage of your portfolio.

All of this is important, because even a small difference in returns translates into significant amounts of money when compounded over long periods. This is not the most important factor, though. Being properly diversified, avoiding common investment mistakes and the quality of ongoing advice and management can have a far greater impact on the success (or not) of your retirement plan.