Before diving into the subject of MER (Management Expense Ratio), there are three terms you need to know.
1. Management: This is the most desirable way to fulfil a task and achieve goals. Firms tend to achieve their solid returns through;
Reporting and Budgeting
2. Expense: The cost incurred in the performance of one’s job or a particular task.
3. Ratio: It is a way to compare the value of two items and processes.
With these terms out of the way, we can explore the Management Expense Ratio subject. We will look at what it means. What Factors influence MER and so much more.
What Is The Management Expense Ratio? (MER)
Management Expense Ratio is a way to measure the administrative and operating expenses of a fund’s asset. Some people refer to MER as simply Expense Ratio. You can estimate it by dividing funds operating costs by the average dollar value of its Assets Under Management (AUM).
Leighann Miko, a certified financial planner (CFP) and founder of Equalis Financial said, “Expense Ratio in its simplest term is a convenience fee for not having to pick and trade individual stocks yourself”.
What Are The Components Of The Management Expense Ratio?
The Three components of MER are:
Management fees: The fee used to compensate the Portfolio managers. Portfolio managers have the sole responsibility for managing your funds. Compensating analysts, and the overall staff. It covers the effort put into conducting research. It also covers management decisions. Similarly, you can think of it as a fee for the firm making your investment decisions for you.
Operating expenses: Legal fees, custodial, auditing, accounting, record keeping and other administrative expenses. Expenses are the fees or costs for running the fund daily. Likewise, Some call it the shareholder service or operating charge.
12b-1 fee: This enables mutual funds to charge distribution expenses. Although, it is set against the fund’s asset. Similarly, it can be put into marketing and selling of shares. For example, paying for adverts and compensating brokers. Furthermore, the firm uses this fee to pay people that sell fund shares. Likewise, they pay for printing and mailing of sales literature. It also includes prospectuses to potential investors.
Factors That Influence The Management Expense Ratio
The factors that influence the management expense ratio include:
1. Sales charges: A fund’s expense ratio represents the amount you owe the fund for the privilege to invest with them. For example, if you were to join a mutual fund with a 2% expense ratio. It would mean that for a $2000 investment, you will pay the fund $20.
Sales charges, brokerage charges or transaction fees are not part of the expense ratio.
Fund management companies that use brokerage firms to sell their funds have to pay for the company’s service charge. It affects their overall fees.
A simple survey can help you find suitable funds for your objectives while leaving more money in your portfolio.
2. The fund’s management style: Various mutual funds adopt unique strategies to ensure that they are profitable. However, the investing style for these funds can either be passive or active. We have Passive Portfolio Management and Active Portfolio Management. Understanding these will help you decide what fund you choose to manage your financial asset.
Passive Portfolio Management is relatively safe. They tend to parallel the returns of particular market indexes. Knowledge of Market Indexes helps to track stock performance.
However, Active Portfolio Management involves the act of trying to outdo the returns of a market index. Firms achieve such results by buying and selling stocks.
Active Portfolio strategies might yield greater returns. However, they are riskier. We advise you to choose a fund based on the risk you are comfortable with. And also consider your investment goal.
3. Size of the fund: The size of the fund is important. It will sometimes influence the outcome of your investment. A fund with a small asset tends to have a high expense ratio. Ideally, you want a fund with a low expense ratio. (An expense ratio within the range of 0.5% and 0.75% is commonly good).
Importance Of The Management Expense Ratio (MER)
When it comes to investing, understanding the cost of an investment is a critical component.
You won’t just buy a product on the market. Whether online or in-store. Checking the price is important. You should always ensure that you check the expense ratio of a mutual fund. Especially if you choose them to handle your investment.
The MER of a fund helps an investor evaluate the nature of their return. A low expense ratio often indicates that the fund is doing well. Also, it suggests that the fund has a low operating cost. A fund’s MER is crucial. It helps you evaluate the following;
Return on Investment (ROI)
Overall investment strategy
By knowing the expense ratio, you can make better choices on how to invest your money.
How To Calculate The Management Expense Ratio? (MER)
Management expense ratio calculations are easy.
You calculate it by dividing the operating cost for a firm by its assets.
Operational Expenses and Portfolio Management Costs
Total Value of Fund’s Assets
The MER total is multiplied by 100. This is done to convert it to a percentage figure from a decimal figure. So that the MER is presented as a percentile.
For example, the ABC mutual fund manages a portfolio valued at fifteen million Dollars. With one hundred and ninety thousand dollars in management costs and expenses.
$ 190, 000
MER = ———————————- x 100 = 1.26 %
Thus, the higher the expense ratio, the lower the return for a given fund performance level. On average, mutual funds have an expense ratio of about 2.5%.
What Is A Good MER In Canada?
Jim Yih, a financial speaker on wealth, retirement and personal finance, stated in one of his articles that the average MER in Canada of all funds is 2.53 %. He said it is imperative to note that all rates of return are published net fees.
In some cases, when a fund writes a 10% return on paper. They most likely have 12.25% without the MER. The fees rarely show up as they are often removed monthly.
Furthermore, with front and back end loads in Canada. Fees can vary between nothing and 5%. And they are deducted from your investment.
For example, if you are investing $10,000. You pay a front fee of 2%. You will pay $200 for the purchase. Meaning $19,800 will get reinvested.
However, in Back end load, you do not have to pay upfront. The longer you stay in the company, the smaller the fee.
Mutual Fund Fees In Canada
Low-cost mutual funds in Canada are difficult to find. It would be easier for you to see a horse go through the eye of a pinhole.
According to a Morningstar report, of the 26 countries in the expense ratio study. Canada happens to be one of the countries with a high expense ratio.
As of 2018, the average expense ratio among Canadian mutual funds was 1.9%. The only two countries with a higher ratio are Taiwan and Italy.
According to the Morningstar survey, Canada has one of the most expensive allocation funds. They include the Open-end mutual funds’ fees in the study.
While exempting closed-end mutual fund fees, exchange-traded funds and other investment pool type fees. The study doesn’t account for the global average of fund fees.
However, it does manage to draw some comparisons on types, equity and allocation. Also draws a comparison of fixed income across several countries.
Investors can take solace in some facts. One of which is that these three factors help reduce fund fees globally.
Increase in competition in the mutual fund industry
The rise of index funds and low-cost Expense Trusted Fund (ETF)
Regulatory initiatives to promote fee transparency
Asset-weighted expense ratios are being pushed down. This is because of a worldwide shift from actively managed funds. To the use of index funds.
Implications Of The Management Expense Ratio
The management ratio effect is significant and crucial. By paying an annual 4% management fee.
You may see an 8% return on your investment statement. It means that your actual return was 12%.
Simply put, it means that 4% of your return covers the fee. In other words, all management fee comes out of your returns. A minor change in the fee percentage can have an impact on your long-term savings.
Mutual funds with a high expense ratio might appear mismanaged, but management and returns can vary.
That is, for higher yields. Similarly, a mutual fund with a low expense ratio can also be incredibly profitable. A high or low expense ratio is not the sole indicator for a mutual fund with good management.
However, return margins depend mainly on the team of managers. Their strategy and the market are also main dependents. Before you seek out a fund, try to study their track records.
Also, consider other investment options before making a decision.
Management Expense Ratio is simply a fee you pay to fund that manages your investment portfolio.
It is a cost that the firm will most likely deduct from your overall return on your investment. It is good practice to study the expense ratio.
Understanding the expense ratio of the firm you want to invest in, will help you make better decisions.
Thanks for reading, please let me know your thoughts and comments below.
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Sagar Sridhar is a personal finance blogger from Canada. His genuine passion for personal finance coupled with his unique style of writing is what stands out. Professionally, he is a computer engineer, agile certified and has a master’s degree in Project Management. His writing has been featured or quoted in the leading Canadian publications such as Credit Canada and many other personal finance publications. While he is juggling between his day job and blogging, he is the main author on this blog and has miles to go before making the final pit stop.