Management Expense Ratio per Quarter Century (MERQ)

Savvy investors know they pay fees to invest in mutual funds and Exchange-Traded Funds (ETFs).  Most of these costs are captured by the Management Expense Ratio (MER).  MERs are calculated by taking the fees charged in a year and dividing by the total fund assets.  By focusing on annual fees, the MER percentage is misleadingly low.  What really matters is how much of your money goes to fees over a lifetime of investing.

For someone who begins investing at age 30 and lives to 85, the total investing period is 55 years.  However, the portfolio is small initially and may be small late in life.  When it comes to the cumulative effect of fees over a lifetime, what matters is how long the average saved dollar is in your portfolio from the day you save it until the day you spend that dollar and all the returns it has produced.  For a nice round figure, I use 25 years as the average holding period for saved retirement dollars.

This gives rise to the Management Expense Ratio per Quarter century (MERQ).  This is the percentage of your portfolio consumed by fees over 25 years.  It’s truly shocking how seemingly small MERs accumulate.  A 2% MER corresponds to a 39% MERQ!  This means that over your investing lifetime, a 2% MER reduces the total amount you get to spend from your savings in retirement by 39%.

If this seems impossible, try starting with $10,000 and taking 2% away 25 times.  This gives $9800, $9604, $9411.92, …, $6034.65.  Because of a technicality in the way MERs are calculated, the actual final value is $6065, for a loss of 39%.

Some people mistakenly believe that an MER only applies to returns their funds’ earn, but this isn’t true.  The MER is charged against all of your savings every year.  That’s why the drag on your savings keeps accumulating year after year.

Whenever you see an MER, I recommend translating it into its corresponding MERQ using the table below to better see how it affects your retirement spending.

MER	MERQ		MER	MERQ		MER	MERQ
0.1%	2.5%		1.1%	24%		2.1%	41%
0.2%	4.9%		1.2%	26%		2.2%	42%
0.3%	7.2%		1.3%	28%		2.3%	44%
0.4%	9.5%		1.4%	30%		2.4%	45%
0.5%	12%		1.5%	31%		2.5%	46%
0.6%	14%		1.6%	33%		2.6%	48%
0.7%	16%		1.7%	35%		2.7%	49%
0.8%	18%		1.8%	36%		2.8%	50%
0.9%	20%		1.9%	38%		2.9%	52%
1.0%	22%		2.0%	39%		3.0%	53%

For the mathematically inclined, the formula is
MERQ = 1 – e^(–25*MER).

It seems shocking that a 3% MER could consume more than half your savings, but it’s true.  This is why it’s so important to pay attention to fees when investing.

As bad as the MER can be, it doesn’t capture all costs.  There are also trading costs within the mutual fund or ETF.  Confusingly, TER usually refers to the Trading Expense Ratio in Canada, and Total Expense Ratio in the U.S.  If you can get the TER for your Canadian mutual fund or ETF, you can add it to the MER before looking it up in the table above.

There are still more costs:

• front and back end loads on some mutual funds
• early redemption fees on some mutual funds
• trading commissions and bid-ask spreads when trading ETFs
• currency exchange costs when trading U.S. ETFs
• unrecoverable foreign withholding taxes on foreign stock dividends
• income taxes

No doubt there are other costs as well.

Many Canadians are getting a poor deal on either financial advice costs, fund management costs, or both.  Most financial advisors offer little to their clients to justify their fees.  Many of the largest mutual funds are “closet indexers” whose management fees are unreasonably high for what is essentially an index fund.  Fortunately, there are good financial advisors and good mutual funds, but it takes some knowledge to be able to find them.  For those who can manage their own portfolios, there are many great low-fee ETFs.

Don’t let anyone try to tell you not to worry about costs.  Be aware of the effects of seemingly low annual fees on your portfolio over your lifetime by focusing on the MERQ instead of the MER.