Finance | Reader Questions | RRSP

Straight Talk About Fees and Penalties on Mutual Funds

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Mr. Canadian Budget Binder received a question from one of his readers and asked me to craft a guest post to answer it.

QuestionCan you explain MER Fees and Penalties regarding investments?

 What Does MER stand for?

MER means Management Expense Ratio. There are a variety of expenses that make up MER.

Some are:

  • The fee paid to the fund managers for managing and investing your money
  • Legal and audit fees of the fund
  • Advisor sales compensation and trailer fees (ongoing service fees)
  • Advertising expenses that promote the fund
  • The cost of buying and selling the stocks the fund holds

How does this impact my investing return?

All published returns for a fund are net returns, after the MER has been deducted. In simple terms Fund A has a return of 10%. Its MER is 2.5%. The net return to the investor is 7.5% Fund B has the same 10% return but has an MER of 2%. The net is now 8%.

The lesson we can learn from this is that lower MER’s usually mean more money for the investor all other things being equal.

Some investors have focused exclusively on buying investments with the lowest cost. There are investments like ETF’s (exchange traded funds) that have very low-cost factors. Some range from 0.15% to 1.40%.  I will comment more on this later.

Sales Commissions, Fees and You

 There are three main ways advisor’s are compensated.

  1. Commission based
  2. Fee- Based
  3. Fee Only

Commission Based

Sales commissions are embedded in the MER to compensate advisors. This can take one of three forms and each has an impact on the investor.

The three commission based options are:

  1. Front End Load
  2. Deferred Sales Charge (DSC)
  3. Low Load Sales Charge (LL)

In the Front-End Load option, the client and the advisor negotiate a percentage of the deposits as a sale commission, usually from 0% to 5%. This percentage is deducted from the investment right upfront. In the long run this is not a good thing for the investor. In addition the advisor would receive a portion of an ongoing trailer fee of 1%. The other portion belongs to the dealer where the advisor does business.

The client, however, can move his/her funds to another fund company at any time without any sales penalties or charges.

In the Deferred Sales Charge (DSC) option, nothing is deducted from the investment. The Mutual fund company pays the Dealer/Advisor an upfront commission. Because they advance the commission they have a penalty if the client leaves the funds from the current company to another company. This is based upon a percentage of the original deposit not the current fair Market Value.

The percentage is on a declining scale and lasts for 6 or 7 years depending upon the fund company. After this time period the investor is free to do what he/she wants without any penalty.

Here is a sample of the Deferred Sales Charge:

An advisor will receive an ongoing trailer commission of 0.5% under this fee option. Again this is shared with the advisor’s dealer.

An investor purchasing funds under this option has 2 relief options. One is he/she can withdraw 10% of the funds value in a given year. The 10% is non-cumulative. In essence if you didn’t use it in years 1 and 2, you can’t withdraw 30% in year 3, just 10%.

Some clients annually move the 10% fee free amount to the same mutual fund but on a zero commission basis. In this way you can indeed accumulate the 10% over time.

The sales charge only applies if you sell some or all of your funds and purchase with another mutual fund company other funds.

The second relief option to the DSC charge is that many fund companies have large numbers of fund options and a move or switch from one fund to another within the same fund family does not incur the DSC penalty.

The low-load sales charge  (LLSC) works similar to the DSC option. However the restriction is limited to 3 years versus the 6 or 7 on the DSC option and the penalty percentages for withdrawals are roughly half of the DSC option.

Traditionally the commission option has been the main way advisors have been paid for their efforts.

Many people argue that the advisor’s compensation should be upfront, known, and factored out of the MER. It should be transparent versus embedded.

This has led to some advisors who charge a fixed percentage of your assets like 1.5% to 2% for smaller amounts of money and a lower percentage for bigger amounts (usually over $250,000) These advisors are known as Fee-Based Advisors.

The cost of advisor compensation is stripped out of the MER and the investor will have MER’s that are about 1% less than before. The investor in turn pays the advisor the fee, which in the past has been paid by the mutual fund company.

Using this type of advisor allows a client to freely move monies from one company to another as they are sold on a 0% front-end load. (A note of caution, this freedom to move at anytime isn’t always a good thing). The only compensation besides the upfront fee they charge is the ongoing trailer fee paid by the fund company.

There are no penalties or charges if a client moves their money to another fund company, other than maybe an account closeout fee that is fairly nominal, usually less than $125.

Fee based advisors if they are licensed for other products such as life insurance etc. can still earn commissions from the sale of those products. The fee-based refers to the investment component.

Fee-Only Advisors

Another variation is that some advisors charge a fee for doing the planning and advising on investments and perhaps life insurance, estate planning etc. This fee can be based upon the nature of work being performed. Some charge hourly, work on an annual retainer, or again as a percentage of your account size. They receive no compensation on the products being purchased. These advisors are known as fee-only.

The investor pays the fee and a client has no penalties if they move their funds to another institution, except for the closeout fee.

Which Option Is Right For You?

I am sure by now you all have an opinion. Let me say there is no perfect answer.

If you have less than $100,000 many advisors will not work with you on a fee only or fee based option, as the earnings don’t properly compensate them for their time and effort. That is why many advisors have an advertised account minimum.

Many investors don’t like the thought of writing a cheque for the fee. If they have $200,000 and the fee is 2% then the cost is $4,000. They could buy under the LLSC and the advisor is properly compensated and there is no fee payable by the client.

All advisors worth their salt will explain in simple English the various compensation options a client has. Then the advisor and client can settle on a mutually acceptable basis of dealing.

What Is More Important Than Costs and Commissions?

MER is important!  Understanding how an advisor is paid and its impact on your investment is important!

However in my 37 years of advising Canadians I think there are two more important factors.

  1. The absence of a financial plan
  2. The biggest determinant of financial failure is behaviour, specifically bad behaviour. It is not the cost of an investment, the commission or fee option being chosen, or the products selected.

Products like Mutual Funds, ETF’s, etc. are just tools to accomplish a goal. In 37 years I find people don’t plan to fail, they fail to plan.

What product solutions you buy should be in the context of an overall plan. However, I have too often seen Canadians buying the product of the month, or the one with the latest high returns published in the newspaper.

The axiom we have all heard is buy low, sell high but because of our own behaviour we buy high and sell low.

 Our behaviour looks like this:


Dalbar every year does a survey on Investor Behaviour. There are many factors they discuss in their Quantitative Assessment of Investor Behaviour (QAIB).

The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.

  • Fact: Since 1991 to the end of 2010 the S&P 500 index had increased by 9.14% annually.
  • Fact: The average investor only made 3.83% ignoring taxes and inflation in the same time period.

One point that caught my attention was the average length of time an investor held an investment fund. (This is a 20-year study)

  • For equity funds it was 3.27 years
  • For fixed income it was 3.17 years
  • For asset allocation funds it was 4.29 years

Implicit in these numbers is the investor chasing the next new big thing.

Email me at if you want the Full Report-It’s Free

I point out these factors to show that yes costs matter but what matters more is managing you own bad behaviour.

My one true value as an advisor to my clients is to prevent them from making emotional decisions that are very costly. I have lived and advised through a long arc of history and I have witnessed many clients make emotionally based investment decisions to their financial detriment.

My job is to act as a sober second opinion and help them take a more reasoned approached to what they do, remind them of history, and that this too shall pass. This is what clients pay me for, to help prevent them from making costly emotional mistakes.

So now you know about MER’s, Costs, How Advisors are paid. I hope you focus on the more important factor in your financial success, Managing Your Own Behaviour.

I am an investment advisor employing behavioural finance principles in my advice giving and a licensed life insurance broker with 36 years of experience helping Canadians achieve financial security. CONTACT INFORMATION: (905) 202-8430 ext.626

You can read more about personal finance at my blog at Gary’s $$$ and Sense

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  1. It is really interesting to know that there are some penalties as well on Mutual Funds. I first time came through such points. “Which Option Is Right For You?” section is really useful for investors.

  2. I’m trying very hard to understand all this stuff, but I’m one that has to be able to read and re-read before I start to understand. Are there any very straight forward books you could recommend that I could look for at the library or buy to help my poor little brain make better sense of all this???? Thanks for the advice and help…it’s an interesting article..

    1. Hi Christine.. Don’t worry I’m learning as well about Investing as I would like to try my hand at doing it on my own. I’m sure Gary or some other PF bloggers might have some book suggestions for us. Mr.CBB

  3. This is a great post – it’s what I really needed to know before I got myself into the funds I’m now. Unfortunately, they also have service charges if I leave before 7 years are up (sigh), but after that..I’ll be free to do what I want – and I’ll be informed this time!

    1. You are not totally bound for 7 years. There is the 10% free option that you can move to a zero commission fund as the same type you own now. My post references that under the DSC description.

  4. Great post! Lots of information that I definitely didn’t know! Maybe one day I’ll have enough money to invest to be able to put that information to use! lol 🙂

    1. What age range are you in if you don’t mind me asking? We’re in our 30’s. The best part that I like about taking the time to understand our finances is the fact that we are actually doing it. When I talk to people that I help and they have no idea what they spend it really motivates me to inspire them to know their numbers. It will make a world of difference. Cheers mate.

  5. Great info here. Bummer that fee-only advisors will only work with clients that have more $$$, but it totally makes sense. My Roth IRA was setup through a fee-only advisor, but I don’t think she does much managing, just kind of set it and forget it. Honestly, I haven’t had the time to do much research to see if I am doing well or not, but my overall snapshot in Mint says I’m underperforming the market. Probably time to “re-balance”

    1. I’m still learning all about what happens here in Canada as it’s all new to me. We don’t have a 100k in investments yet but we are not far off. I’d like to take the time now to learn as much as I can and that’s why I enjoy guest posts from professionals who know their stuff. Thanks for popping in mate…

  6. Great post. I am actually looking to do a similar post as well here in the near future. I would tend to say, in general, a fee only advisor is best so you can make sure they are not being compensated for what they’re putting you in. In general, I am not a huge fan of mutual funds due to the fees associated with them. I’d rather go into a cheap index fund or individual stocks instead.

  7. Most people see the markets increasing and they want to get in on the gains. What they don;t realize is that the market as already ran up 5 or 10 percent and there is most likely a pullback in the near future. They buy in anyways and then after the pullback and fees it takes them a year just to get back to even. I think psychologically everyone thinks they can invest on their own, but that is far from the truth.

  8. We use the Dalbar study as well and I believe they said “sophisticated investors” (those with $100k+ in their accounts) were the ones that averaged only 3.83%.

    It’s interesting to see the reality of what people earn when trading and timing the market, yet 95% of people still beat that drum because it plays into their personally fear/greed emotions and it’s precisely what most people WANT to hear. Most people believe that timing the market is a good thing because it’s easier for me to tell a client: “hey, things are going to get a little choppy with the election, let’s move over to something a little more conservative.” Nobody wants to hear…”well, we’re not precisely sure what’s going to happen, so let’s stay put and just let the market do what it does.”

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