THIS IS A MUST READ FOR EVERY ADVISOR
Malcolm Hamilton, an actuary and pension consultant with William M. Mercer Ltd., in the Introduction to Jonathan Chevreau's The Wealthy Boomer, provides this handy "rule of 40":
Take 40. Divide by your mutual fund's MER. And presto, you've got the number of years it takes management expenses to consume one-third of your investment.
Warning: Now if you think that's painful then you may not want to read further.
Assume a mutual fund's MER is 2%. In the first year you pay 2% of your fund as an MER, leaving 98%, i.e.
1 - MER = 1 - 0.02 = 0.98
In the second year you pay 2% of the remaining 98%, leaving 96.04%, i.e.
In the third year you pay 2% of the remaining 96.04%%, leaving 94.12%.
Now if you think this sounds bad, stop reading any further. It gets worse. Much worse. Those nasty little MERs don't include the cost of brokerage fees, bid/ask spreads and other expenses that are charged directly to the fund. Those extras can easily add another 1% or even more to the annual erosion of your fund. Actively-managed funds incur higher costs due to their usually higher levels of trading. And small cap funds lose even more each time they trade a stock due to the wider bid/ask spreads.
And remember, like MERs these extra fees pile up regardless of how you fund performs.
But wait there's more!
So far the analysis applies only to tax-sheltered accounts like RRSPs. In a taxable account you'll also have to share your returns with the taxman.