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What on-going costs do I pay as a mutual fund investor?

All mutual funds have management and operational or administrative costs that you pay indirectly. Many people do not realize they are paying these fees because they are deducted from the fund before it publishes its returns. The expenses are charged to your investments regardless of whether the fund makes you money or not.

A management fee is paid to the mutual fund management company for its portfolio management expertise. This fee may vary depending on whether you paid a sales commission when you bought the fund (a front-end sales charge), when you withdraw money (a back-end or deferred sales charge) or if you have a no-load fund (no sales charge). Some fund companies offer negotiable management fees, with the percentage you pay declining as the amount you invest in a fund or family of funds increases. Others have management fee structures that reward the fund manager for better than average performance. Operational and administrative expenses include legal and auditing costs, regulatory filing fees, accounting and marketing costs, transaction costs and on-going service payments to your advisor. The ongoing payments your advisor might receive are called service or trailer fees. They are paid as long as your money stays in the fund. The fee varies from about 0.25% to 1% per year of the money you have in the fund. Controversy has surrounded trailer fees in recent years, because they raise the possibility of conflict of interest. Since trailers differ from fund to fund and between fund companies, there is a financial incentive for an advisor to sell the fund that pays the higher trailer fee. There is also an incentive to keep clients in mutual funds rather than move their money into other products such as GICs or Canada Savings Bonds, which might serve the client better. The industry's argument is that trailers are meant to pay advisors for their ongoing services, such as answering questions about your account. It is also argued that the trailer fee amount is based on the value of the assets in the fund, so it is in your advisor's interest to help you choose your funds wisely. As assets grow, so does the advisor's trailer fee. If you want to know what trailer fee your advisor stands to earn on particular funds, you can ask your advisor what the trailer fees are, or look up the fee schedule in the fund's simplified prospectus. If your advisor is recommending one particular fund, ask what would be his or her second and third choice of funds. By checking the trailer fees of all three funds in the prospectus, you can see if there's any incentive for your advisor to recommend one fund over the others.

Management Expense Ratio

The management expense ratio (MER) is a useful tool to compare the ongoing costs of investing in different funds. It tells you roughly how much you are paying in management fees and expenses each year. The MER takes all but a few of the different expenses and expresses them as a percentage of the fund's value. If the fund is worth $1 billion and the management fee and operational expenses amount to $25 million, then the fund will have a MER of 2.5%. If your investment in the same fund is worth $10,000 then you will have paid $250 in management fees and expenses in the year. An expense that is not included in the MER is transaction costs. This can be a significant cost to you if your fund does a lot of buying and selling. Although MERs might appear to be small percentages, they have an impact on a fund's performance and can add up over the long term. A MER of 3% rather than 2% on a fund which generates a 12% annual return means you end up with a return of about 8.6% instead of 9.7%. The difference in return may seem minor, but it adds up over time. A $20,000 investment that earns 9.7% a year for 20 years would grow to $127,398 - compared to $104,142 at 8.6%. That's a $23,256 difference - not small by most people's standards.