Sometimes, a 2% fee is no big deal. A 2% charge to use a credit card to buy a $4 bag of chips at a convenience store? That’s eight cents well spent when you’ve got a craving that won’t quit. But if we’re talking mutual fund fees, waving off 2% can be an expensive accounting error — one that many investors make. A 2% fee costs you a lot more than you think, even if your fund does well.
What a mutual fund fee actually represents
When you invest in a mutual fund, you’re charged a Management Expense Ratio (MER) fee, which is usually between 1% and 3%. The MER includes the fee for managing the fund, operating expenses, and taxes. Mutual funds are considered a high-fee fund compared to other investing approaches, like ETFs (exchange-traded funds), which have minimal fees (often between 0.05% and 0.15%).
But what is the MER a percentage of? That’s what many investors get wrong. A 2% fee isn’t 2% of your original investment in the mutual fund. It’s 2% of your total ending balance, meaning that when your balance grows, your fee does, too.
Let’s say a mutual fund offers an expected return of around 8%. That seemingly no-biggie 2% fee is going to swallow up around 25% of your return. In other words, your expected return is more like 6%. Here’s what that hidden math looks like when you plug in dollar amounts:
Your initial investment: $1,000,000
Your balance after an 8% gross return: $1,080,000
The 2% MER (charged on the total balance): $21,600
Your final net amount: $1,058,400
A high bar for returns
Because mutual fund fees take such a big bite out of your gains, the fund’s manager has to work extra hard to match the returns you’d see from a lower-fee fund.
Let’s say an ETF charges you 0.10% in fees. If the market sees returns of 8% and the ETF tracks alongside it, you’re netting 7.9%.
In order for a mutual fund to get you that same 7.9%, the fund can’t just match the market; it has to beat it by 2%. In other words, it needs to generate a gross return of 9.9% so you can pocket 7.9%.
What about when the market drops? In a bad year, you’ll still be paying that 2% fee, but now it’s on top of the market’s loss. If the market drops by 8%, you’re down by closer to 10% thanks to fees. Using the same amount as before, this is what that could look like:
Your initial investment: $1,000,000
Your balance after an 8% market loss: $920,000
The 2% MER (charged on the total balance): $18,400
Your final net amount: $901,600
Why the fee is only half the problem
The other half: skewness.
Skewness is a statistical term that describes the asymmetry of how returns are distributed. Instead of stocks evenly contributing to the distribution of gains, it’s a small handful of big winners that drive most of the market’s gains.
What does skewness have to do with mutual funds? Most active mutual funds spread their money across a variety of stocks to stay diversified, which usually means their exposure to those big winners is diluted. That’s why the median mutual fund tends to trail the market, even before fees even come out. Add the fee in, and the performance gap between the market and the mutual fund gets wider.
The compounding issue
Gains aren’t guaranteed, but your mutual fund fee is. You might not notice it at first, but like a tiny leak in a blow-up mattress, you’re going to eventually feel its effects. Enter compounding.
When your gains generate further gains, compounding is great. But it can also work against you. Your lost earnings can generate further lost earnings. After a down year, losses and fees can stack, making a bounceback hard to pull off. You’ll need bigger gains than usual to get back to even, plus you’ll continue paying a fee that scales with your balance.
Even if the fund consistently does well, a fee reduces your principal balance every year and quietly shrinks your final nest egg. The table below breaks down exactly how much wealth mutual fund fees can wash away over an investment lifetime, compared to ETF fees. Spoiler alert: it’s a lot.
The lifetime cost of mutual fund fees
Here’s what could happen if you were to invest $100,000 in a mutual fund that generates a hypothetical 8% annual return rate and keep your money invested for 30 or 40 years with no additional contributions.
Notes:
Lines 1 and 4 show the hypothetical lower-fee ETF comparison.
The last column shows the difference between the hypothetical growth of $100,000 with a consistent 8% annual return with no fees and the hypothetical final portfolio value minus the associated annual fees.
These figures are strictly for illustrative purposes only; they don’t represent actual market projections or return rates for any specific ETF or mutual fund.
Time horizon | Investment product / Annual fee | Net annual return (after fees) | Final portfolio value (after fees) | Potential wealth lost to fees | Value with no fee (8%) |
|---|---|---|---|---|---|
| 30 years | ETF: 0.15% | 7.84% | $961,955 | $44,311 (4%) | $1,006,2656 |
| 30 years | Mutual fund A: 1% | 6.2% | $744,335 | %261,931 (26%) | |
| 30 years | Mutual fund B: 2% | 5.84% | $548,902 | $457,364 (45%) | |
| 40 years | ETF: 0.15% | 7.84% | $2,045,846 | $126,606 (6%) | $2,172,452 |
| 40 years | Mutual fund A: 1% | 6.92% | $1,453,309 | $719,143 (33%) | |
| 40 years | Mutual fund B: 2% | 5.84% | $968,263 | $1,204,189 (55%) |
Know what you're paying (and what you’re getting in return)
If you want to invest in mutual funds, you’re going to pay fees. Full stop. That doesn’t mean that mutual funds are a bad investment. You just need to know what you’re getting into — what the fee is, what you’re getting in return, and deciding whether it feels like fair value to you.
First, find the MER. Every mutual fund is required to give investors a fund facts document, which will state the MER and explain what it covers.
Understand whether your MER is on the high or low end. Fees can range widely from one mutual fund to the next. It’s essential to know where on the range your MER sits, because it can make a huge difference when it comes to compounding losses. The table above shows just how dramatically losses can compound over an investment lifetime when fees go from 1% to 2%.
Weigh cost against value. There is no magic percentage that makes a mutual fund fee “worth it.” Fees pay for — at least in part — real things, like financial planning and personalized advice that keeps you strategically invested. It’s up to you to decide whether that fee makes sense to you.
Alternatives to mutual funds
Remember, mutual funds are just one way to invest. If a mutual fund fee doesn’t make sense for your investment strategy, there are plenty of solid, lower-cost options that can help you meet your goals.
ETFs
Like mutual funds, ETFs hold a diversified basket of individual stocks, government bonds, corporate bonds, or other securities. Unlike most mutual funds, ETFs are typically passively managed. They track an entire index or market, like the S&P/TSX Composite index or the Canadian bond market, using an algorithm rather than a human fund manager. That means fees are often much, much lower.
GICs
A Guaranteed Investment Certificate (GIC) locks in your investment at a financial institution for a fixed period of time in exchange for a predictable rate of return. There is no management fee associated with GICs and the financial institution that holds the GIC guarantees the amount you invested. Even if the institution went underwater, GICs are insured up to $100,000. The returns can be much less exciting, but in exchange you get minimal risk and no cost.
Self-directed stock trading
With an investment account and some solid research, you can buy and trade stocks on your own. Most brokerages charge a commission per trade (often between $5 and $10), but some offer zero-commission trading. You won’t pay any additional fees unless you engage the services of an advisor to help guide your purchases and trades.
Automated portfolios
Automated investing is a hybrid between self-directed investing and total portfolio management. You choose your holdings and how your money is allocated, and an investment platform then auto-monitors your portfolio, some of them will automatically rebalance it based on your settings, others will alert you when you need to do it yourself. Pricing can be varied, but the fee is usually a fixed percentage that is capped at a certain dollar amount, or sometimes a flat monthly fee.
Takeaways
A mutual fund fee applies to your entire balance (including accumulated returns), not just your original investment.
The dollar amount of the fee grows with your balance, and is charged whether it’s an up year or a down year.
Good performance doesn’t cancel the fee out, and bad performance deepens your losses and leaves you with less money to recover with.
The majority of active mutual funds usually trail the market (even before accounting for fees).
The fee compounds into a significant lifetime cost (and the higher the fee, the worse the compounding effect).
There is no hack for avoiding fees, and no magic fee percentage. Every investor needs to weigh cost vs. value for themselves.
