It's not free to run an Exchange Traded Fund (ETF), and market makers expect to be compensated for creating, managing, and making markets for ETFs. As holders of ETFs, we expect to pay these kind of fees, but it is important to understand how much you are paying for funds you hold.
MERs can range from as low as 20 basis points (0.20%) to as high as 3% depending on the type of fund and management company. It has a huge effect on your returns over time.
What is included in MER?
The total expenses you see when looking at fund MER’s includes both:
- Fee to the fund company running the fund (i.e. the manager’s profit for running the fund)
- Operating expenses to manage the fund (this will include taxes, interest, custodial fees, servicing costs, brokerage fees, advertising and any other overhead)
While it is easy to imagine that funds will have differing amounts of administrative expenses (and they do), the biggest item to watch out for is the investment advisory / management fee charged by the fund company.
Note that some funds also charge backend/deferred charges that are essentially a sales fee - make sure to understand whether or not you are being charged these fees.
Why does MER matter?
The fees you pay on a fund are subtracted directly from that funds returns, regardless if the fund went up or down.
For example, on a fund that returned 6%, if the management expense ratio is 1.5%, you will see a 4.5% return on your investment. Similarly, if the funds investments drop in value by 8%, you will see a return of -9.5% due to the additional fees.
This will have a huge impact on your retirement portfolio performance. Given that a “typical” range for assumed stock returns in on the order of 4-8%, and MERs range from 0.2-3%, the fees you are paying can easily eat up 50% of your fund returns in a given year. Even the cheapest funds can still eat a few percentage points of your return over time.
Because the MER reduces your returns every year (whether the market goes up or down), you don’t only lose out on those annual returns, but also on the compound growth of the fees you’ve paid. We created the graph below to show this effect - assume for the moment you have $50,000 to invest for 20 years, and the market will always return exactly 7% (wouldn’t that be great!).
You can see that the fees paid in a 2% MER fund vs a 0.5% MER fund compound over time - the 0.5% fund has nearly $50,000 more at the end of 20 years, simply due to the fees you are paying each year. Obviously this can have a huge impact!
How do I find out how much an ETF is charging in fees?
It is fairly simple to find out how much a fund is charging in fees.
You can go straight to the providers website (just Google it) - the screenshot below shows where this information is located for a Vanguard fund.
You can also look this information up for most funds using Yahoo Finance - the screenshot below shows where this information is located for an iShares fund (in the ETF "Profile" tab").
What are some examples of Management Expense Ratios?
The fee charged on an ETF will vary with the provider of the fund, and the type of the fund. Typically funds with more complex/specialized investment mandates will charge higher fees.
- Vanguard S&P 500 (VOO): 0.05%
- iShares S&P 500 Index (IVV): 0.07%
- Vanguard Total Stock Market ETF (VTI): 0.05%
- iShares Core S&P Total U.S. Stock Market : 0.07%
- Vanguard FTSE Developed Markets (VEA): 0.09%
- iShares MSCI EAFE (EFA): 0.34%
- QuantShares US Market Neutral Size (SIZ): 1.49%
The most important thing you need to know is that ETFs will charge you a percentage of returns (in up or down markets) in order to run the fund. This fee can vary widely and can have a huge impact on your portfolio value over time.
Make sure you understand what you are paying!