When analyzing a mutual fund prospectus, an investor will find the term MER. This stands for Management Expense Ratio, and it is a measure of the various expenses incurred by the fund on an annual basis. When a mutual fund or fund rating service publishes its annual return, it is the net return achieved after all expenses. Therefore, if two mutual funds had identical annual returns, the fund with the higher MER actually performed slightly better.
There are two types of open end mutual funds: load and no load. Loaded funds are mutual funds purchased through a broker that pays the broker a sales commission. No load funds are purchased directly through the mutual fund company and no sales commission is charged. While sales commissions are not a part of MER, they must be accounted for when selecting a mutual fund. Any actively managed mutual fund (and all open end funds are actively managed) is going to incur expenses from marketing, research, salaries, and the MER for some funds will be higher than others.
A high Management Expense Ratio can have a negative impact on an investor's overall return. All things being equal, a fund with a lower MER will have a higher rate of return than a fund with a higher MER. Simply put, higher expenses detract from the rate of return.
When researching mutual funds, it is important to keep MER in mind. However, some mutual funds will naturally have a higher MER than others. For example, a fund in a very volatile sector like international growth is more management intense than a money market fund and will therefore have much higher expenses. With that in mind, it should provide a much higher rate of return. An investor shouldn't necessarily avoid mutual funds with a high MER as long as the fund provides a high rate of return.
Management Expense Ratio is a good way to compare several mutual funds in similar sectors to determine which is the best investment. With similar investment strategies and similar annual returns, MER can be the deciding factor among a group of funds. If the market takes a turn for the worse, theoretically the funds with a lower MER will fare better than those with a high MER.
It is a good idea to analyze one's mutual fund holdings at least annually. A fund that performed well last year may not be positioned to do so again next year. Some fund managers lose touch with the market and can no longer provide the returns to justify their high salaries. Salaries and marketing fees are the largest components of MER. If a fund is performing poorly, keep an eye on the MER. If its MER is higher than better performing funds, it might be time to sell.
Dave Guilford has been a freelance newspaper and magazine writer for more than 10 years. As a former stockbroker, commodities trader and life insurance agency owner, he writes on personal finance, investing, insurance and retirement planning. A former international yacht racer and yacht brokerage owner, Guilford is a frequent contributor to "BoatU.S. Magazine." His work has also appeared in "Latitudes & Attitudes Magazine."