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.

Mutual Funds: Great for portfolios up to $100,000

Posted by Preet on Jul 28, 2007 | 0 comments

I suppose many financial advisors licensed to sell ONLY mutual funds will cringe at this information. First, I want to say that if you have more than $100,000 in your portfolio it does not automatically mean that it is time to get out of mutual funds. But certainly once you pass this threshold you will want to look at alternatives to mutual funds as your options open up (based primarily on the fact that buying in bulk reduces your trading costs). If you remember in my first post on Mutual Funds we defined mutual funds as being the ideal investment for SMALL investors because trying to build your own diversified portfolio would cost too much in trading commissions.

So once you have built your portfolio past $100,000 it is time to compare costs of paying a mutual fund manager versus the costs of having a stockbroker build a custom portfolio (or yourself with a discount brokerage trading account if you have the knowledge).

Let’s look at the average Equity Mutual Fund. It has an MER (Management Expense Ratio) of approximately 2.6%. That means that for every $100,000 in your portfolio, you are paying $2,600 per year for management. When you were starting out your savings, perhaps you had $5,000 in the fund at the end of your first year – you were only paying $130 in fees. In fact, that is quite a bargain considering your advisor probably spent much time meeting with you, learning about your situation and creating a plan and investment recommendations. He or she does this so that when you become a larger investor, you become a larger source of income for the advisor. Also, by having built a relationship over time, it becomes a strong bond and there is less likely a chance that another advisor will lure you away (all thing being equal).

But let’s say you stay in this fund and now your portfolio has reached $1 million. You still pay 2.6%, and in this case you are now paying $26,000 in fees for the same management. It starts to get depressing if you consider that $26,000 every year could buy a new mid-size family car!

So let’s look at two options:

1. Fee based advisor

A fee-based advisor works on a set percentage of assets – think of it as similar to an MER, except that in the industry it is called a “Client Advisory Fee”. You don’t pay a trading commission for each stock purchase setting up the portfolio and similarly you can sell those stocks and buy new ones without incurring a separate commission. The Client Advisory Fee pays for all your trading costs, account admin fees, everything. Even if the Client Advisory Fee was the same as the MER (2.6%), it is advantageous because this fee can be written off for tax purposes whereas an MER cannot (for non-registered investment accounts only, you cannot write off fees for an RRSP). For easy math’s sake, let’s assume that our client is in a 50% Marginal Tax Rate. If they could write off the 2.6% Client Advisory Fee, then it effectively becomes reduced to 1.3%. That is a huge saving right off the bat.

But, it only gets better. While Client Advisory Fees usually can only be offered for $100,000+ sized accounts, this fee can be reduced automatically as the portfolio grows even larger. For example, the fee might be 2.5% up to $249,999 but once you reach $250,000 the fee might drop to 2.25% (and that would apply to the whole account, not just the funds over the threshold). Every advisor and firm have their own set of thresholds and fees – but know that you can negotiate the fee. As accounts grow to $1 million you should easily be able to negotiate the fee down to 1.25% (which, for a non-registered account could be written off and effectively reduce the fee to 0.625%) . When you set up your fee-based account, you will sign a document that clearly outlines the thresholds and fees for each level.

2. Transactional Advisor

In this case you pay a commission for each transaction – i.e. to buy or sell an individual stock. While it would take you maybe 20 purchases to setup the portfolio initially, and just for argument’s sake let’s say each transaction cost you 3% of the purchase price, then your first year would cost you roughly 3% in fees. BUT, once you’ve setup the portfolio most of the work is done, and the rest is maintenance. For example, you made 20 transactions in the first year, but in the second year you only made 6 transactions because it was time to sell 3 stocks, and you needed the other transactions to buy replacement stocks. So perhaps in the second year your total fees were only 0.9%. It all depends on how many trades you make in the year. (If you are an active trader, endlessly trading stocks then you already know you should be on a discount trading platform designed for active traders. )

It is important to note that you can replicate the characteristics of the mutual fund you’ve left with individual securities. But it might be more important to note that you can modify it now according to your personal preferences as well as paying a lower amount of fees every year.

I recently moved a client from another institution to my care. He had a portfolio of $180,000 entirely in mutual funds with an MER of 3.03%. We setup a fee-based account with a client advisory fee of 1.5% up to $1 million, and it would reduce to 1.25% over $1 million when he gets there. It was a non-registered account so he can also write off the Client Advisory Fee. Let’s do the math:

Before:

$180,000 x 3.03% MER = $5,454 yearly cost

After:

$180,000 x 1.50% Client Advisory Fee x 50% Write off of fee = $1,350 yearly cost

This client will save roughly $60,000 in fees over a ten year period. This will be due to the fact that the portfolio will appreciate over time and the yearly savings will also increase.

This is another “no-brainer” investment decision quite frankly. If you have over $100,000 in your investment portfolio, it’s time to speak to your advisor about fees. They would rather lower their income and keep you as a client then lose you and get NO income… And of course if your advisor can only sell mutual funds, it may be time to look for a full service broker who is authorized to sell everything (mutual funds, stocks, bonds, etc.).

What is a Mutual Fund? A basic understanding…

Posted by Preet on Jul 26, 2007 | 0 comments

I suppose this should be one of the first posts seeing as how most people are invested in mutual funds (and have no idea what they are, what the differences are between them, and what kinds of mutual funds there are out there). It is also of note that many investors might be better off getting out of mutual funds at a certain point… but I’ll get into that in another post!

A mutual fund is a means for small investors to pool their money together (MUTUALLY) with other small investors so that they may hire a Mutual Fund Manager to take the collective funds and create a diversified investment portfolio that is invested on behalf of all the small investors. If Investor A has $1000 of his/her money in the mutual fund and Investor B has $10,000 of his/her money in the mutual fund and the Mutual Fund Manager has guided the portfolio to a 10% return, then Investor A now has an $1,100 stake in the fund and Investor B as an $11,000 stake in the fund.

So you might be wondering who the charitable soul is who has decided to manage this investment portfolio on all these investors’ behalf? Well, don’t you worry! He/She gets paid, and paid well! One of the most oft reported pieces of information on mutual funds in the media is what is known as the MER of the fund.  MER stands for Management Expense Ratio and is in essence how much money is paid to the Mutual Fund manufacturer in order to cover all costs of running the fund.  This includes the pay for the mutual fund manager, his/her research team, support staff, the paper your statements are printed on, the lights and phones in the office, not to mention paying the mortgage on the building and property, advertising the fund, etc. Oh, yeah it also includes the commission your financial advisor may earn for selling the fund to you and maintaining a relationship with you.

The MER is deducted before all performance reporting. So in the example above, if the MER of the mutual fund was 2%, then the mutual fund manager was actually able to generate a 12% return.  Once the 2% MER was deducted, we are left with 10%.

Most people are quite content to pay 2% (and not really noticing it because it doesn’t show up anywhere on their statements) (Then again, most people don’t even know that they are paying it!).  Once you actually break it down for people (and when you are dealing with larger and larger investment portfolios) then they start to pay more attention. For example if someone with a $1 million dollar portfolio is paying a 2.5% MER and there is a similar fund out there with a 1.5% MER, that’s $10,000 being left on the table every year. If we apply the same thought process like we did with the savings account question, multiply that amount by a couple of years and the foregone growth and it quickly become a matter of hundreds of thousands of dollars if not millions!

But of course, we have to look at why people would want to use a mutual fund in the first place. Well if you have $1000 dollars to invest, you are not going to get a very diversified portfolio if you try to buy a bunch of stocks individually. The commissions per transaction would eat up a sizeable chunk of your $1000 right off the bat.  You may need to earn a 30% return just to break even!  And if you could do that with confidence I’d be wondering just how it came to be that you only have $1000 to your name!  That is why I kept using the words “small investor” in the beginning of this post. Once you have a larger portfolio (generally speaking, nearing $100,000) you CAN start to create a diversified portfolio without brokerage costs killing you.

The other point to mention is that some people use mutual funds because they want a dedicated team of experts handling their hard earned cash. Remember a mutual fund manager and his/her team works almost ’round the clock and they are immersed in the world of investing and have studied long and hard to get where they are.  So a lot of people who don’t have the time, knowledge or desire to handle their investments will hire a professional to do it for them.

Okay, I think that is probably enough of a primer on mutual funds to get started with.  Let’s let that sink in before getting back into it… because there is a lot more to it, that’s for sure!