Mutual Fund Trailer Fee Disclosure – Good Move, But Won’t Make Much Difference

by Mike Holman

I agree with Rob Carrick that better disclosure of mutual fund fees and rate of return is worth the extra cost to investors. I’ve already written in the past however, that while I think more mutual fund fee disclosure is good, I doubt it will make much of a difference.

Most investors don’t read anything other than the account balance on their statements.  Even if an investor does read about trailer fees and rate of return, they would still need to know what the numbers mean and if they are paying an amount appropriate to the service they are getting.

I can’t get people to look at their investment statements, but I can explain mutual fund trailer fees and personal rate of return.

What are mutual fund trailer fees?

Trailer fees are ongoing fees which are taken out of each mutual fund you own and paid to the company your advisor works for.  The advisor will receive a cut of the trailer fee.

Most equity funds charge 1% annually which is based on the daily balance of your fund.  If you have $100,000 of mutual fund A and that balance never changes – you will pay $1,000.00 in trailer fees in one year.  Of course, all mutual funds do change value on a regular basis, so the trailer fee calculation is done on each business day.

The important fact to know is that these fees are taken out of the mutual fund itself and is reflected in a slightly lower price for your funds.  The fees are not currently shown on statements and you will never be asked to pay the fees directly.

It’s very easy for an investor not to realize that trailer fees exists.  It’s kind of like getting a paycheque which only shows your net pay and doesn’t indicate the gross pay or any of the taxes taken out.

What is a mutual fund personal rate of return vs the rate of return for the fund?

A mutual fund return is the investment performance as calculated for a mutual fund.  A personal rate of return is a combination of the mutual fund return and the activities of the investor.

For example a company might advertise that a fund has a “12% annualized five year return”.  This means that if you bought this fund exactly five years ago and didn’t do any other transactions, your return would also be 12% annualized.

But what if you bought it four years ago?  Is your personal return still 12% annualized?  It’s possible, but not likely.  If a good chunk of the positive five year return occurred in that first year, then your four year annualized return will be lower than 12%.

The other factor is your activities with the mutual fund.  When you buy mutual funds, do you purchase a lump sum and then never make more purchases or take money from that fund?  Because all transactions you do in a fund will affect your personal rate of return.

How to get investors clued in?

The most effective way to get investors to realize how much they are paying in commissions of any type is to get them to pay the fees directly.  Currently the fees all come out of the mutual fund and the investor never “pays” any fees and in most cases, have no idea how much the fees are or that they even exist.

Banning imbedded fees would mean that the financial industry would have to charge these fees directly to the investor, as in the investor will have to write a separate cheque for the money.  This won’t help the issue of an investor not knowing if they are getting a good deal, but they will definitely know how much they are paying.

Explaining the rate of return is difficult.  One suggestion would be to put the benchmark return on the statement along with the fund return, but even that is tricky.  If you own a mutual fund, the fees go to pay the administration and portfolio management of the fund as well as paying your advisor.  Those fees will be taken out of the performance of the fund, so it’s apples vs oranges to compare an active mutual fund you have purchased through an advisor with a do-it-yourself ETF.

Are you getting value from the advisor? Are they helping with tax info, asset allocation? You are paying for these services through the fees which impact returns. It might be worthwhile, but that’s something you have to evaluate yourself.

What do you think?  Will more disclosure of these fees make much of a difference?

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{ 10 comments… read them below or add one }

1 IntelligentSpeculator

I completely agree.. it’s a good step, but not nearly enough. It’s not an easy problem to tackle unfortunately.. I just got my sister to switch to an ETF portfolio which will end up saving her a ton of money over the next few decades.. but most investors have no idea what kind of fees they’re paying or how those compound over time

2 John Buchanan

I agree that most investors don’t know what MER or trailers are. Why can these fees not be deducted from your income tax? Making them deductible would require the mutual fund companies to report the fees and investors would then be aware of the fee.

3 Freddie

What I’ve done, as a pay for fee planner, is a spreadsheet that shows all the mutual funds that a client has and takes the average value of each fund over the past year. Then for each fund class (eg. Cdn Equity) I calculate the amount paid as MER and trailer fees, and the average annual return of these funds over the past 5 years.

Then similarily I show the amount paid in MER for a comparable ETF and the corresponding annual return for the ETF over 5 years.

It’s a pretty easy sell when they see the savings in fees and then you add on the benefit of being able to sell the ETF at any time for a small broker fee ($10) for annual rebalancing or cashflow needs (mostly applies to retirees). Don’t forget that mutual funds also charge either front end or back end loads which also reduce the annual returns and can play havoc with annual rebalancing at least in the short term (5 to 10 years after purchase).

This exercise then gets the difference down to something the customer can understand and that is “$$$ savings” per year. Of course this is not perfectly accurate but is good enough for discussion purposes.

4 Thomas Venner CFP

The fees are only tax deductible in a non-registered account. If you meet fund/account minimums some funds allow the advisor and client to set the trailer fee by signing a separate agreement. In non-reg account the fees can be tax deductible, fees are still paid to advisor by fundco but it is way more transparent.

5 Mike Holman

@Intelligent Speculator – Good for you for helping your sister.

@John – Interesting idea, but not sure if the government will agree.

@Freddie – That sounds great. Hopefully your clients are smart to understand that.

@Thomas – Thanks.

6 Michael James

Whether or not fee disclosure makes any difference depends on how the fees are disclosed. It wouldn’t be hard to hide this information among the other junk that obfuscates many account statements.

7 Roger @ The Chicago Financial Planner

I’ll admit to being unfamiliar with the fee structure of Canadian mutual funds, but I gather from this post and some prior conversations with Jon Chevreau and others that funds with trailers and loads are pretty much the norm. I also gather that Vanguard has started to make some inroads in Canada, I hope they gain some traction with their low fee index offerings. As a fee-only advisor here in the U.S. I strive to put clients in low cost funds and ETFs. Often I can save them significant dollars via my access to many institutional share class funds. I don’t recall ever buying a mutual fund at any price other than NAV.

8 Thomas Venner CFP

I explain fees this way: if you have $100k of assets with me in mutual funds you pay a fee from those assets that will total between $500 and$1000 depending on the asset mix, my dealer gets 34% and I am paid the rest. I tell them this is money you are paying for Financial Advice. I am a Financial Planner and have expertise in tax preparation, mortgages, estate planning, insurance etc. I tell them I have reference materials with valuable information on budgeting and debt management. I encourage my clients to get their monies worth by calling/emailing me any time with any questions relating to their financial well being.

9 Ken Kivenko

Providing personal rates of return for accounts will open investor eyes.
That should lead to some healthy dialogue between investors and dealer Reps ( aka “advisers” )

Kk

10 Mike Holman

@MJ – Very true.

@Roger – Things are very different here. :)

@Thomas – It sounds like you are a model financial advisor. The problem is advisors who just do sales planning instead of financial planning. They are not earning their commissions and it’s up to the clients to figure that out.

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