Do fund management expenses matter?

Mutual fund management expenses take a meaningful chunk of your funds’ asset values. And they do so year after year. But the real question should be whether what you get after costs is worthwhile.

Fund ManagementWhen you’re considering funds for investment, how much emphasis should you place on fees? Much has been said and written about mutual fund expenses. Mutual funds publish an expense schedule in their prospectus, and management expense ratios, or MERs, show up in most online sources featuring mutual funds.

The MER shows all expenses as a percentage of the fund’s net asset value, excluding trading expenses. Management expenses include the fund manager’s fee plus other, outside expenses incurred by the manager on behalf of the fund. These include legal and accounting services. The manager’s fee includes the cost of managing the portfolio plus other aspects of the fund such as keeping track of investor accounts, legal matters, details of distributions and income-tax implications; and, yes, advertising, promotion and sales motivation.

Most funds publish changes in their asset value daily. And returns calculated from these values are after deducting the fees and expenses noted above. So what you see is, in most cases, the net return to investors.

Fund suitability is your primary criterion

When you choose funds, your first consideration should be your investment personality and your goals and needs. That means consider funds that match your tolerance for risk and time horizon. And consider funds that add real diversification to your overall portfolio. In short, choose suitable funds.

But if you’re comparing, say, a few large-cap Canadian stock funds for your portfolio, should MERs weigh on your decision? Yes, but only as a tie-breaker.

Within a category of suitability, the final difference between funds will be performance, plain and simple. In retrospect, the fund that provides the higher return after expenses and with the appropriate level of risk will have been the right choice. Problem is, of course, that in retrospect, it’s too late to make the choice. You have to choose in the beginning.

You can look at past performance in comparison to a similar fund—an indicator of management capability. But as the ads always say, it’s no guarantee of future performance. It is, however, an indicator.

Nonetheless, an expense ratio is more than an indicator. It’s a guarantee that investment performance will be reduced by a greater or lesser amount.

When you look at past performance, you’re already looking at expenses—even if indirectly. After all, you’re looking at the manager’s capability to cover expenses. And a manager with a consistently superior performance has produced superior results after expenses, whatever they may be.

But a low-fee fund has a head start that gives it a predetermined advantage.

A fund that outperforms its peers more often than not does so after expenses. So always choose a fund that seems to have superior management. But if the differences are slight, a low fee could tip the balance.

This is an edited version of an article that was originally published for subscribers in the August 17, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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