TER: The Trading Expense Ratio or Total Expense Ratio?

Posted by Preet on Mar 23, 2010 | 1 comment

By now, most people have heard of the MER (Management Expense Ratio) in mutual funds and ETFs. Another term that gets bandied about is the TER, which is less well known and has a few different meanings depending on which country you are in.

Meaning 1: TER = Trading Expense Ratio (Canada)

When you look at a Canadian fund’s MRFP (Management’s Report on Fund Performance), it is now required to show the Trading expense ratio of the fund which represents the amount of trading commissions incurred to manage the portfolio as a percentage of the total assets of the fund. For example, if you had a $100 million fund and the trading commissions for the year incurred by the fund manager to manage the portfolio was $1 million then the Trading expense ratio is 1%. This is NOT reflected in the MER. Funds with higher portfolio turnover rates (meaning the manager buys and sells more often) or funds that invest in less liquid securities (like micro-caps for example) will have higher Trading expense ratios. Funds with low turnover and that invest in larger-cap names will have lower Trading expense ratios. Here is a screen-shot of an MRFP report which shows where you can find the Canadian TER:

In this case, you can see that the TER is 0.73%. If you add this to the fund’s MER of 2.46% you will get a truer sense of the total costs to run this fun.

Meaning 2: TER = Total Expense Ratio (US and UK)

Now to really throw a wrench into things: TER as the Total Expense Ratio means different things based on what country you are in. In the UK, the Total Expense Ratio is the same thing as the MER in North America. But in the US (predominantly) the Total Expense Ratio is the MER + Trading Costs.

Here’s a little breakdown…

In the UK the TER stands for Total Expense Ratio and is equal to the US or Canadian definition of MER

In Canada the TER stands for Trading Expense Ratio which is the cost of commissions paid in the fund as a percentage of the fund’s total assets.

In the US, TER stands for Total Expense Ratio and is equal to the US or Canadian MER + Trading Expense Ratio.

Yeah, I know.

The Staying Power of Mutual Funds: Finally At Risk

Posted by Shishir Nigam on Mar 22, 2010 | 3 comments

This is a guest post penned by Shishir Nigam. I met Shishir a few years ago while giving some presentations at the University of Toronto. Now, he is the Founder of ActiveETFs | InFocus (http://etfshub.com), the only site on the web providing focused coverage of Actively-Managed ETFs. He is also Chief Editor at Young & Invested (http://youngandinvested.com).

The Staying Power of Mutual Funds

Mutual funds are ingrained in nearly all retirement portfolios, whether we’re talking about RRSPs in Canada or 401(k) plans in the US. They’re so ingrained that in the US, most of the operational systems used to invest client funds can only handle mutual funds because they are designed to settle 1 day after a purchase or sale, whereas other products such as ETFs and stocks settle 3 days after a purchase or sale. When operational limitations like this are the biggest challenges to new products entering these retirement portfolios, instead of the actual merits of the product, you know the incumbents will not be giving up share to ETF issuers easily.

The Numbers

When Preet gave me the opportunity to write something for the readers of WhereDoesAllMyMoneyGo.com, I decided I’ll start by presenting the most important facts people need to know about the mutual fund versus ETF debate.

Canadian mutual funds are considered to have some of highest fees in the world. This was first concluded by a study in 2007. Canadians on average had to pay an expense ratio of 2.56%, compared to 1.29% worldwide and 1.11% in the US. This is largely a product of the oligopoly that is the Canadian mutual fund space, with the 5 major banks taking up the biggest market share. Here’s what this means in $ terms. The chart below shows you what two portfolios, one using ETFs and one using mutual funds would look like over 20 years, with markets providing a 5% annual return. I’ve given the mutual funds the benefit of the doubt by using a 2.20% expense ratio, assuming they would have become slightly more competitive since 2007. And I’ve used a 0.75% expense ratio for ETFs. The difference in fees creates a final difference of more than $5,300 on a portfolio that started off with $10,000.

What’s keeping mutual funds in their place?

What I’ve presented above is not news to anyone reading this article, the benefits of ETFs have been clear and well-discussed on this blog and many others since ETFs really took off in the last few years. But despite this, the penetration of ETFs into traditional portfolios has been slow. I have a theory on why that is, and why that might be about to change.

The superiority of ETFs was confirmed in 2009 when for the first time assets managed by Index ETFs overtook those managed by index mutual funds. But take note, this progress was restricted to the passively-managed space. Passive or index mutual funds make up only about 10% of all mutual funds, with the other 85-90% being actively-managed. Which brings me to my point – despite years of debate on the inability of active management to provide any benchmark beating returns, investors have continued to pile into active funds. This I believe is due to investors just not being satisfied with index returns.

People like to put their faith in a star manager whom they believe can do well, and faith is an often underestimated quality. People want a knowledgeable market expert to at least attempt to beat the market, rather than settle for the market return. Given an offer to receive a guaranteed $25 or a 10% chance to receive $200, most people will take the chance even though the math is against making that choice, because they believe in themselves to beat the odds. And this is what we see in the active versus passive debate as well, where investors believe they can choose the market-beating manager. With most people looking to invest their money in active strategies, ETFs haven’t been an option because of their passive nature even though they are cheaper and more tax efficient etc. But that’s changing.

Actively-Managed ETFs enter the stage

Actively-Managed ETFs differ from traditional ETFs in that the money you put into these products is actually managed by a portfolio manager practicing active management, attempting to beat the market and their benchmark, just like every active mutual fund. So in essence, Active ETFs now provide those investors looking for active management (which is most of them) the option to get what they are looking for through an ETF structure.

Active ETFs debuted in the US in 2008 and in Canada in 2009. Today, there are 5 providers of Active ETFs in the US and 1 in Canada. Head here for a complete listing of current actively-managed ETFs. Most of these products are managed by stars from the active space that investors can put their “faith” in.

What all this means is that finally, both categories of investors, those looking for active managers and those just looking to follow an index, have a way to invest through ETFs and benefit from the 4 main advantages that they bring. Mutual fund issuers might have just lost their monopoly on the last carrot they had been able to dangle in front of investors all this while – the promise of active management.

Thanks Shishir – some good points to consider. I’ll add that the long-term fee impacts are magnified when using a lower cost index ETF portfolio which may have a blended portfolio MER of lower than 0.75% – which makes it all the more compelling.

A Lap Of The Blogs

Posted by Preet on Mar 18, 2010 | 5 comments

If you are new to WhereDoesAllMyMoneyGo.com, every Friday I run a post called “A Lap Of The Blogs” which provides links to articles I found interesting and think that others may want to read for themselves. I also sometimes include some commentary on what’s going on in my personal life and a weekly “racing video” since my former life was in the auto-racing industry. The name “Lap of the Blogs” is in reference to “A Lap Of The Gods” which is an old video series which chronicled on-board footage of the world’s greatest F1 drivers lapping various racetracks from around the world. NOTE: you have to visit the actual website to see the embedded video – it may not appear in your email. Just click on the title of the email to see it…

Work is taking me out to BC for the next week, but while I will be away from home I will have the opportunity to have dinner with Squawkfox who runs a fantastic blog. Check it out here.

From Around The Blogosphere

Mortgage Free? Ask for a discount on your home insurance by Canadian Capitalist.

In defense of hedge funds appearing on Dr. Mark Wolfinger’s blog.

How Annuities Work by Million Dollar Journey.

Tenants paying my mortgage by Four Pillars.

Is your financial advisor a Yes-Man? by Michael James on Money.

Property tax redux by Big Taxin’ Man.

One over-looked tax credit by L_Mac.

Can hackers read RFID chips on credit cards? by Jonathan Chevreau.

How many bank stocks should be in your dividend portfolio? by Thicken My Wallet.

This Week’s Racing Video

The British program “Top Gear” has a test track that celebrities and race drivers attack in an underpowered compact car to compete for bragging rights. This video has F1 star Mark Webber trying his hand. Enjoy!

Discretionary Investment Management

Posted by Preet on Mar 17, 2010 | 0 comments

Discretionary investment management is an arrangement where an investor hires a Portfolio Manager to manage money according to a set of parameters without having to discuss every transaction that takes place on an ongoing basis. I capitalized Portfolio Manager because it is a special type of registration that requires a certain amount of experience and either the completion of the CFA designation (Chartered Financial Analyst) OR completion of Level I of the CFA curriculum PLUS completion of the CIM designation (Canadian Investment Manager). Just because an advisor is a PM, doesn’t mean that all their client accounts are managed on a discretionary basis though.

One of the benefits for the advisor is that if they are running a large book of business, lets say they run $100 million in equities and $100 million in fixed income, then instead of having to call 200 of their clients to tell them about a trade idea they can just make one large transaction and then divide the number of shares amongst their accounts later. Discretionary clients have already established with the advisor the general parameters of how they want their accounts managed, and either don’t have the time to discuss every transaction with their advisor or don’t want to bother pretending they know what their advisor is saying.

Account minimums for discretionary accounts vary, but are in the $250,000+ range normally. Fee charged by the advisors (potentially tax-deductible for non-registered accounts) vary tremendously. Most people don’t know that you can negotiate fees with these types of advisors. Fees are almost always tiered (reduce as assets in the account increase).

Reader Question on Multiple RRSP Accounts

Posted by Preet on Mar 16, 2010 | 1 comment

A reader emailed in the following question and I thought I would share my answer with everyone:

Question

My question is specific to my situation obviously, but could apply to anyone in their 30s who’s changed jobs a few times and now has multiple RRSPs.

The first RRSP is a mutual fund group plan left over from my previous employer, that I still contribute to monthly, and that I borrowed 20,000 from to buy a house with 2 years ago.  It’s managed by a private investing firm here in Ottawa.  The second RRSP is a mutual fund group plan with my current employer that I also contribute to monthly (it also has a Deferred Profit Sharing Plan portion that also has a matching employer contribution).  This one is managed by Manulife but I can make changes to it online if I want.

For a few years, I was transferring all the money from my current employer RRSP to my previous employer RRSP because I thought it was better to keep one larger account growing steadily rather than having 2 separate RRSPs each of lower value.  This way I also had access to an advisor whenever I called them up, but I didn’t trust their advice since it would likely have me put all my investments with them anyway.

I hope that’s clear as mud!  What’s your take on something like this?

Answer

First a clarification – this could apply to pretty much anyone, not just people in their 30′s.

Many people will contribute to their current Group RRSP to enjoy the free company matching benefit, and once the employer contributions have vested (usually a two year period, but it can be longer or shorter) they will transfer the assets out annually to a different financial advisor/firm to enjoy greater investment options or cheaper investment options in some cases.

The rationale provided by the reader is actually a little different though – he postulated it was better to have one larger account as opposed to two. Mathematically, there won’t be any difference – all things being equal. Again, the main reason someone would annually transfer out vested contributions is to take advantage of lower costs and/or greater investment options. You will also want to keep an eye on annual account fees – not all firms have RRSP annual account fees, but some can be more than $100/year. If you have multiple accounts, each with annual fees – it can really add up.

The last statement is a bit confusing though as the reader indicates that by doing it this way he would have access to an advisor, but didn’t trust him anyways. Group RRSPs *can* offer less personalized advice, sometimes only a call centre with an occasional on-site workshop, but sometimes they are administered by “regular” advisors just like any other account. But the bigger question is the lack of trust in the advisor. Perhaps he should consider finding a more transparent advisor, or a fee-for-service advisor who works by the hour – their compensation would not be derived from product recommendations.

Hope that helps. I know there are some knowledgeable readers on this site – feel free to chime in with other suggestions or experiences.

Higher Deductibles for Lower Insurance Premiums

Posted by Preet on Mar 15, 2010 | 11 comments

I thought I would share a personal story today about automobile insurance. Most people are familiar with the concept of a higher deductible leading to a lower insurance premium. For those that are not, let me explain it really quickly:

The deductible is essentially the amount that you pay out of pocket if you need to make a claim. For example, if you have a $500 deductible and get into an accident that caused $1000 damage to your car, you would pay the first $500 and the insurance company would cover the rest. If the damage was $501, you would still pay $500 and then the insurance company would cover the $1 remaining – of course you may not want to file the claim in that case for a measly dollar, but you get the point.

If you raise the deductible, from say $500 to $1000, then your premium goes down because the insurance company has less on the line. There would be more minor accidents that wouldn’t even be worth claiming in this case since the threshold for payment is now $1000.

A few years ago, I realized that I had been driving for 12 years and not once had an accident. I figured I could save a few bucks by raising my deductible from $500 to $1000. I forget the exact number but it dropped my premium by about $100/year. I figured that as long as I could avoid having an accident more than once in every 5 years I would come out ahead. If I had an accident, I would have to pay $500 more than before, but I would save $500 every 5 years (not factoring the possible increase in premiums due to multiple accidents though).

A week later I was talking to a co-worker about my new camera phone – all the rage back then – and one great use was for insurance claims. If you got hit in a car accident you could take photos of the accident scene to corroborate your story if need be. Well wouldn’t you know it, but the VERY next day I get plowed into (t-boned) by an 18 year old in a parking lot who had his license a whole 6 months. He absolutely gunned it right into my driver’s side rear wheel.

Really? This just had to happen right after I raised my deductible?

I remember thinking to myself, as I was taking pictures with my new camera-phone of the “crime scene”, that as long as I don’t get into another one in the next 5 years, I’m okay… lol

As luck would have it though, since the accident was so clearly the fault of the other driver who admitted fault right away, HIS insurance actually covered everything and there was no claim filed on my policy at all. So I didn’t have to pay a penny and I have been saving that $100/year ever since. So far, that has been the only accident I’ve had.

Hopefully by writing about it, fate won’t pull the old camera-phone lesson on me again though, and I won’t get into an accident tomorrow.  Good lord, what have I done…

Options Gurus Set Up Paid Educational Website

Posted by Preet on Mar 14, 2010 | 1 comment

I use options in my own portfolio but only rarely write about them. I will try to write more option-related material in the future, but for those who are interested in learning more right away you might be interested in a new site set up by some of the top option bloggers on the internet. The new website is called “Expiring Monthly“.

One of the contributing authors is Dr. Mark Wolfinger, and you may want to read the interview I had with him on this blog by clicking here. I consider him to be a real straight shooter and so when he approached me to help promote his site there was absolutely no hesitation on my end. However, he did indicate that he was offering affiliate commissions for referrals to the site who end up subscribing, so in the interests of disclosure let me make it clear: I receive monetary consideration for people who sign up for the Expiring Monthly website (price is $99/year).

I realize that over the weekend I had posted an affiliate link for Questrade, but rest assured the back-to-back affiliate offers are simply a matter of coincidence. I don’t actively look for affiliate opportunities, and it will probably be months and months before you see another, and it will always be disclosed. The flip-side is that I’m planning on giving away an iPad on the blog in the near future (as soon as they are available for pre-order in Canada which should be in a few weeks).

I’ll let the guys behind Expiring Monthly provide their own commercial and simply cut and paste their introduction page below, but the amount of knowledge Dr. Wolfinger gives away on his blog for free is testament to the value he can provide. Now multiply that by 5 authors.

I normally don’t endorse anything on this blog, but if you have ever considered signing up for one of those ridiculous option trading system seminars which you pay $1000 for a three day workshop near you and promise you that you can quit your job and sustain yourself trading options, save yourself. In this case, I would say you should really consider Expiring Monthly as you will learn practical, no nonsense information.

So, like I said – if you have an interest in options trading check it out. If not, then stick around anyways because I’ll be announcing an iPad giveaway in the near future for having to put up with the back to back affiliate posts! :)

One final note – they are holding a raffle for all people who sign up for their website and prizes will be a number of books and an private mentoring session with an options trading pro.

Now to Expiring Monthly’s description:

*****

Expiring Monthly is the brainchild of five of the top options bloggers on the Internet:

• Adam Warner of the Daily Option Report

• Bill Luby of VIX and More

• Jared Woodard of Condor Options

• Mark Wolfinger of Options for Rookies

• Mark Sebastian of Option 911.

Our goal is to provide a monthly magazine in digital format that’s informative to new option traders, yet interesting to the most experienced traders.

If you trade options, Expiring Monthly is your magazine.  We never want you to outgrow this publication

Every issue of Expiring Monthly contains a Feature Interview and an Extended Feature Article.  Our Follow The Trade feature tracks at least one trade per month from entry to exit, with appropriate commentary.

We have a few humorous trading anecdotes, along with all the insight, analysis,  market commentary, and trading tips you expect from our writers.

More features are planned, including Book Reviews.  If you suggest a feature, we’ll give it serious consideration.

*****

Click here for more information: Expiring Monthly Website.