Not A Litre Of Milk: Evaluating The Utility Of Management Expense Ratios, Part One

The point: When you buy mutual funds from the bank, or an advisor, or through your employee plan, how do you know if you're getting what you're paying for?

I'm not a fortune teller, but I can probably guess what mutual funds you hold in your RRSPs. You have at least one "Monthly Income fund", something with "Dividend" in the title, and a managed portfolio of some kind, probably called "Managed Aggressive Growth" or "Managed Balanced"...right?

You might have all sorts of things, and today's not the day we talk about overlapping investments, or active strategies vs. passive strategies, or even whether mutual funds are the best investment vehicle ever (or not). Nope, today we're talking about price tags. 

I know the value of stickers, believe me.

How often do you walk into a store and buy something without looking at the price? Depends on the store and the item, doesn't it? I rarely look at prices at the Dollar Store because I have a pretty good idea how much items will cost and how much utility I'll get out of them (hint: not much, unless we're talking about stickers + an 11 hour trip to Pennsylvania with three kids under five, and then LOTS).

When I shop at the grocery store, it's another thing entirely, especially in the meat section. I plan my menu, scrutinize unit prices, and try to walk the (very thin; often invisible) line between "not enough" and "too much" food for the hungry pack of monkeys at home.

While it's not always an easy calculation, it's easier to understand the connection between price and utility when you're dealing with cheap glassware, stickers, or chicken thighs because trading money for stuff (useful or not) is something you do almost every day. It doesn't take much analytical research to determine that $1.99 per pound for green chicken thighs isn't a good deal no matter how you look at it. When you're dealing with mutual funds, however, the price tag is hard to understand, easily talked around, and disclosed to death, and therefore it takes real effort for regular people to understand and calculate the utility of what they're buying.

Now, understand that I'm not talking about the investments themselves. The unit price as a statement of the market value of the underlying securities isn't at issue here. But - unless you're at a level where you're buying stocks and bonds directly from the issuing companies and not paying commissions on the purchase or fees to hold them in a brokerage account (in which case, why are you here?) - you're paying money to invest, and you should be able to understand what you're getting so you can evaluate if it's worth it.

Simple, right? Sure. Well, let's start with what you pay for when you buy a mutual fund. 

Everyone enjoys a nice, rousing game of "find the disclosure", right?

If you buy mutual funds through a bank, you're probably buying "no-load" mutual funds. There's nothing you have to pay to buy or sell. Your advisor will ask you all of the mandatory Know Your Client questions, and apologetically hand you the prospectus, copies of the account documents, and one or more fund facts sheets.

The Management Expense Ratio of the particular fund(s) you're buying will be mentioned in passing, or at least circled in one or more of the disclosure phone book that just landed on the desk. What will never be discussed, or at least it will be discussed rarely enough to be statistically considered never, is what relation that management expense ratio (MER, for short, and because my fingers are already tired) has to your invested money.

See, you don't think about MERs because they're not listed as a line item on your quarterly statement and you don't have an automatic bill payment set up for them. They're tucked tidily away inside your mutual funds, reported as a teeny-tiny sounding percentage of the net asset value, meek, mild, and forgotten. What's a little 2.25% among friends? Or in the grand scheme of things?

Except - since it's money that you and all the other million people invested in the same mutual fund are paying to the folks who are doing the work of investing for you - it's kind of important. Just because it's not a litre of milk, or a sheet of stickers, or a car, you're not excused from the responsibility to evaluate the utility of your spending when you buy mutual funds.

Stay tuned next time, kids, when we talk about how to actually do the evaluating.