Money & Career
Investing in mutual funds? Learn these 5 terms to discover how you can get the best value from your investment
Money & Career
Investing in mutual funds? Learn these 5 terms to discover how you can get the best value from your investment
I know how opaque most financial jargon is to investors, which is why I've selected five key examples from the fund world to explain here. This stuff is vital if you want to get the most value out of your fund investments.
1. Management Expense Ratio (MER)
In simple terms, the MER tells you how much it costs to own a mutual fund. It's preferable to have a low MER than a high one when selecting funds.
Here's how the MER works. First, almost all the fees associated with running a fund are gathered together, including management and administrative fees. Next, these fees are compared to the total assets in the fund. What you end up with is a ratio showing you the percentage of the fund's assets that are eaten up by fees every year. Of course, those assets aren't just sitting there. They're invested in stocks, bonds and other stuff and hopefully earning a return that offsets the fees charged by the fund. Want to know how much a fund needs to make to break even? Just look at the MER. If it's 2.5 per cent, then a gain of 2.5 per cent is needed to get to the break-even point.
One of the most common fund questions I get from investors is, Do fund returns reflect the impact of the MER or not? The answer is yes. Fund companies publish net returns in virtually all cases. Put another way, fund companies take their cut before investors get paid.
MERs are not closely guarded secrets. You can get fee information on fund company websites, in fund company brochures and from websites like Globeinvestor.com and Morningstar.ca. Still, many investors are, by and large, clueless about the cost of owning funds. It's so easy— just check the MER.
I said earlier that the MER includes almost all the fees associated with a mutual fund. Curious about what isn't included? Mainly, trading costs— the brokerage commissions a fund pays for buying and selling securities. These trading costs can add as much as one percentage point, perhaps even more, to a fund's total cost, depending on how much trading a fund manager does. You can find hard information on the cost of trading in a mutual fund's semi-annual management report on fund performance. Look for the trading expense ratio, or TER, which expresses trading costs as a percentage of fund assets. Add the MER to the TER and you've got the total cost of owning a fund.
2. Trailing Commission
Also known as trailer fees, or just trailers. Never wondered how investment advisers who sell mutual funds get paid? You're not alone— a lot of investors are sold funds by advisers without having a clear picture of how the adviser is compensated for the transaction and subsequent service on your account.
Now that you've read the preceding section on management expense ratios, you know all about the big package of fees that eat into a fund's returns. A major component of those fees is the trailing commission. If you own an equity fund with an MER of 2.25 per cent, it would be typical for one percentage point to be accounted for by trailers. The trailer is paid by the fund company directly to the adviser, who shares it with his or her firm. Let's hope you're getting great service from your adviser, because he or she is getting paid well through trailers, regardless of how your account is doing.
Page 1 of 3 - More terms to decipher on page 2.
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.3. Deferred Sales Charge (DSC)
There was a time when a large majority of the fund purchases in this country were made with a deferred sales charge, which is to say these funds were sold with no upfront commission at all for investors. Instead, these investors put themselves in a position of having to pay a redemption fee— a deferred sales charge— if they cashed out of their funds within the first six or seven years after buying.
The DSC was invented as a way of helping investors circumvent huge upfront sales commissions that were a big turnoff. The problem with DSCs is that they're like financial handcuffs. If you want to sell a fund, whether because of terrible performance or your own personal financial need, you could well have to pay fees of up to 5 or 6 per cent of your investment.
Today, an ever-decreasing percentage of fund sales are made with a DSC, but some investment advisers still actively promote them. The reason is that a fund company will pay an adviser more initially for selling a DSC fund than for selling funds with an upfront sales commission. Selling funds with upfront commissions can be more lucrative over the long term for advisers (because the trailing commissions are higher). But if an adviser needs income right now, he or she will prefer the DSC and accept lower trailers over the long term. (How's your financial health? Take the quiz and find out!)
4. Zero Load
Interviewing a new financial adviser from whom you expect to buy mutual funds? One of the first questions to ask is whether he or she sells mutual funds with a zero load. A zero-load fund is one where the upfront sales commission has been set at zero or, in other words, waived entirely. Thus there's no commission to pay when buying these funds, and there's no deferred sales charge to worry about if you want to sell later on.
Zero-load advisers have been growing in number, but they remain in the minority. Often, zero-load advisers are well-seasoned professionals who have large books of business and can afford to live off the trailing commissions they get from the funds they've sold over the years. Young advisers may also sell on a zero-load basis as a way of attracting new clients who might be turned off by upfront sales commissions or deferred sales charges.
Don't mistake zero-load funds for no-load funds, which are entirely different. No-load funds are sold by banks and small, independent fund companies, and investors can always purchase them with no upfront commissions or deferred sales charges. Zero-load funds, you'll remember, are essentially funds with an upfront sales commission that has been waived at an adviser's discretion. (Before you buy: 5 investment mistakes to avoid.)
Page 2 of 3 - Find out how to judge stock performance on page 3.
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.5. Benchmark
This is a term you'll come across in all aspects of investing, not just in the fund realm. A benchmark is a reference point that allows investors to correctly judge the performance of a fund or portfolio of stocks. Typically, benchmarks are widely recognized stock and bond indexes.
Maybe you own a Canadian equity fund and you're becoming more and more convinced it's a complete washout. You keep reading about how the stock markets are soaring, but your fund barely moves. How can you accurately judge your fund? Find the appropriate benchmark and compare returns over various time frames. For a broadly based Canadian equity fund with virtually all of its assets in Canada, the S&P/TSX composite is the correct benchmark (even better is the S&P/TSX composite total return index, which includes dividends). For U.S. equity funds focusing on big blue-chips, use the S&P 500 stock index. For global equity funds, use the MSCI World Index. For international equity funds, use the MSCI Europe Australasia Far East (EAFE) Index. The fund profiles available on Globeinvestor.com handily provide all the benchmark data you need to get the lowdown on the funds you own.
Don't give up on your fund because it has lagged on the market over a year or so. A much better way to use benchmarks is to compare them to your fund's returns over a period of five or ten years. Any fund at all can have a bad year. What matters is how it compares to the benchmark over longer periods.
More great money advice from CanadianLiving.com:
Quiz: What's your financial savvy? 8 easy ways to save money How to get a fresh start on your finances How to protect your parents from fraud
Page 3 of 3
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.
1. Management Expense Ratio (MER)
In simple terms, the MER tells you how much it costs to own a mutual fund. It's preferable to have a low MER than a high one when selecting funds.
Here's how the MER works. First, almost all the fees associated with running a fund are gathered together, including management and administrative fees. Next, these fees are compared to the total assets in the fund. What you end up with is a ratio showing you the percentage of the fund's assets that are eaten up by fees every year. Of course, those assets aren't just sitting there. They're invested in stocks, bonds and other stuff and hopefully earning a return that offsets the fees charged by the fund. Want to know how much a fund needs to make to break even? Just look at the MER. If it's 2.5 per cent, then a gain of 2.5 per cent is needed to get to the break-even point.
One of the most common fund questions I get from investors is, Do fund returns reflect the impact of the MER or not? The answer is yes. Fund companies publish net returns in virtually all cases. Put another way, fund companies take their cut before investors get paid.
MERs are not closely guarded secrets. You can get fee information on fund company websites, in fund company brochures and from websites like Globeinvestor.com and Morningstar.ca. Still, many investors are, by and large, clueless about the cost of owning funds. It's so easy— just check the MER.
I said earlier that the MER includes almost all the fees associated with a mutual fund. Curious about what isn't included? Mainly, trading costs— the brokerage commissions a fund pays for buying and selling securities. These trading costs can add as much as one percentage point, perhaps even more, to a fund's total cost, depending on how much trading a fund manager does. You can find hard information on the cost of trading in a mutual fund's semi-annual management report on fund performance. Look for the trading expense ratio, or TER, which expresses trading costs as a percentage of fund assets. Add the MER to the TER and you've got the total cost of owning a fund.
2. Trailing Commission
Also known as trailer fees, or just trailers. Never wondered how investment advisers who sell mutual funds get paid? You're not alone— a lot of investors are sold funds by advisers without having a clear picture of how the adviser is compensated for the transaction and subsequent service on your account.
Now that you've read the preceding section on management expense ratios, you know all about the big package of fees that eat into a fund's returns. A major component of those fees is the trailing commission. If you own an equity fund with an MER of 2.25 per cent, it would be typical for one percentage point to be accounted for by trailers. The trailer is paid by the fund company directly to the adviser, who shares it with his or her firm. Let's hope you're getting great service from your adviser, because he or she is getting paid well through trailers, regardless of how your account is doing.
Page 1 of 3 - More terms to decipher on page 2.
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.3. Deferred Sales Charge (DSC)
There was a time when a large majority of the fund purchases in this country were made with a deferred sales charge, which is to say these funds were sold with no upfront commission at all for investors. Instead, these investors put themselves in a position of having to pay a redemption fee— a deferred sales charge— if they cashed out of their funds within the first six or seven years after buying.
The DSC was invented as a way of helping investors circumvent huge upfront sales commissions that were a big turnoff. The problem with DSCs is that they're like financial handcuffs. If you want to sell a fund, whether because of terrible performance or your own personal financial need, you could well have to pay fees of up to 5 or 6 per cent of your investment.
Today, an ever-decreasing percentage of fund sales are made with a DSC, but some investment advisers still actively promote them. The reason is that a fund company will pay an adviser more initially for selling a DSC fund than for selling funds with an upfront sales commission. Selling funds with upfront commissions can be more lucrative over the long term for advisers (because the trailing commissions are higher). But if an adviser needs income right now, he or she will prefer the DSC and accept lower trailers over the long term. (How's your financial health? Take the quiz and find out!)
4. Zero Load
Interviewing a new financial adviser from whom you expect to buy mutual funds? One of the first questions to ask is whether he or she sells mutual funds with a zero load. A zero-load fund is one where the upfront sales commission has been set at zero or, in other words, waived entirely. Thus there's no commission to pay when buying these funds, and there's no deferred sales charge to worry about if you want to sell later on.
Zero-load advisers have been growing in number, but they remain in the minority. Often, zero-load advisers are well-seasoned professionals who have large books of business and can afford to live off the trailing commissions they get from the funds they've sold over the years. Young advisers may also sell on a zero-load basis as a way of attracting new clients who might be turned off by upfront sales commissions or deferred sales charges.
Don't mistake zero-load funds for no-load funds, which are entirely different. No-load funds are sold by banks and small, independent fund companies, and investors can always purchase them with no upfront commissions or deferred sales charges. Zero-load funds, you'll remember, are essentially funds with an upfront sales commission that has been waived at an adviser's discretion. (Before you buy: 5 investment mistakes to avoid.)
Page 2 of 3 - Find out how to judge stock performance on page 3.
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.5. Benchmark
This is a term you'll come across in all aspects of investing, not just in the fund realm. A benchmark is a reference point that allows investors to correctly judge the performance of a fund or portfolio of stocks. Typically, benchmarks are widely recognized stock and bond indexes.
Maybe you own a Canadian equity fund and you're becoming more and more convinced it's a complete washout. You keep reading about how the stock markets are soaring, but your fund barely moves. How can you accurately judge your fund? Find the appropriate benchmark and compare returns over various time frames. For a broadly based Canadian equity fund with virtually all of its assets in Canada, the S&P/TSX composite is the correct benchmark (even better is the S&P/TSX composite total return index, which includes dividends). For U.S. equity funds focusing on big blue-chips, use the S&P 500 stock index. For global equity funds, use the MSCI World Index. For international equity funds, use the MSCI Europe Australasia Far East (EAFE) Index. The fund profiles available on Globeinvestor.com handily provide all the benchmark data you need to get the lowdown on the funds you own.
Don't give up on your fund because it has lagged on the market over a year or so. A much better way to use benchmarks is to compare them to your fund's returns over a period of five or ten years. Any fund at all can have a bad year. What matters is how it compares to the benchmark over longer periods.
More great money advice from CanadianLiving.com:
Quiz: What's your financial savvy? 8 easy ways to save money How to get a fresh start on your finances How to protect your parents from fraud
Page 3 of 3
Excerpted from Rob Carrick's Guide to What's Good, Bad, and Downright Awful in Canadian Investments Today. Copyright © 2009 by Rob Carrick. Published by Doubleday Canada. Reproduced by arrangement with the Publisher. All rights reserved.
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