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Break free from the mutual fund fee trap

Dale Jackson

Canada excels at a lot of things. Unfortunately, mutual fund fees are one of them. Of all the developed countries in the world we pay the highest on average.

What's worse — the industry is structured to leave few options for regular investors wanting exposure to the world's riches.

Fee breakdown

The squeeze begins with the management expense ratio. The MER is an annual fee based on the percentage of the total amount invested whether the fund goes up in value or down. It covers expenses like portfolio management, administration and marketing. In most cases a cut, called a trailer fee, goes to the mutual fund dealer who originally sold the fund — each year — for ongoing advice like, "Yes, I think you should hold the fund for another year."

Some mutual fund companies pay higher trailer fees to dealers than others, which brings into question whether you're being sold the best fund for you or the dealer.

Some mutual fund companies impose other fees on top of the MER such as front-end loads based on a percentage of the amount invested initially, and back-end loads based on a percentage of the total amount when the fund is sold. In some cases redemption fees or fees to switch funds within the same fund company are also imposed

As your nest-egg grows those fees can really add up. As an example, a typical diversified portfolio of mutual funds would have an average MER of about 2.5 per cent. At $10,000 that's $250 a year. At $100,000 that's $2,500. At $1-million that's $25,000. Remember that guy who sold you those funds back when you were struggling to make an RRSP contribution? With a trailer fee of one per cent he's getting paid $10,000 every year to say "Yes, I think you should hold the fund for another year."

The rich get richer

The mutual fund fee structure leaves few alternatives for those struggling to break free.

If you're looking to switch to an investment provider that charges based on an hourly rate, rather than commission, you may be out of luck. Most fee-based advisors won't even consider clients with less than $400,000 in assets.

Large portfolios can sustain more cost-effective fee structures allowing good financial advisors and brokers to make a decent living on smaller percentages of total assets, along with trading fees and commissions. As a result, those percentages, fees and commissions tend to drop as assets rise.

So what are mid-level investors to do? There are a few good financial advisors who will take you on if they feel you're a committed, informed investor. They have to make a living too and spending hours explaining the basics to novice investors is hardly worth the fees generated on $60,000. Keep in mind they probably have hundreds of other clients like you.

The best place to start looking is the investment arm of the institution that administers your other financial needs like chequing/savings accounts or a mortgage. Some of the big banks focus on the client as a whole and nurture a lifetime relationship that delivers them a lifetime of fees. They often provide a variety of investment accounts, with a variety of services and varying fee structures.

They can also offer basic advice on strategy, risk management and tax efficiency.

If you go this route there are two things to keep in mind: 1. An advisor can not give your investments the care and attention you may need so keep close tabs on your own account. Nobody cares about your money like you. 2. Understand and keep a close eye on fees.

Going it alone

There's always the option of striking out on your own through a discount brokerage.

Trading fees vary from brokerage to brokerage. Some offer discounts for several trades, which introduces a basic problem common with do-it-yourself investors — the tendency to over trade.

Several studies have shown investors who manage their own money tend to trade on emotion. They buy when everyone else is buying at the top, and sell when everyone else is selling at the bottom.

In addition to breaking the basic rule of "buy low, sell high" they tend to trade when the best course of action is no action.

Discount brokerages are better suited for traders and not investors. Traders trade - investors implement long-term strategies aimed at growing whole portfolios.

If you still want to go it alone you can start saving on fees by replacing your Canadian equity mutual fund with an exchange traded fund (ETF) that tracks the Toronto Stock Exchange.

The Canadian stock market is relatively thin and you will find the same big companies in both. Curiously, returns for the TSX tend to exceed the average mutual fund by about the same percentage as the MER - suggesting many fund managers are closely tracking the index.

You can even break free from the small annual ETF fee by simply buying the biggest companies on the TSX individually.