You need to be aware of potential conflicts of interest before you start investing.
An FKD Feature exclusive

When you’re getting ready to invest some things are more important to know than others: MER and AUM are at the top of the must-know list.

When we decided to do a bit of acronym-busting, to help demystify the whole “putting your money in the stock market” thing, we knew we had to take on MER and AUM first. They stand for “management expense ratio” and “assets under management,” and they’re how a huge portion of the investment management industry makes money.

These are two of the acronyms you should look for anytime you’re talking about someone else managing your money; whether they’re a robo-advisor, a financial advisor or some guy at your bank who’s recommending a mutual fund. That’s because they’re two terms that talk about how you pay for the advice they’re giving you – and you should always know how you’re paying for advice.

First up, let’s talk management expense ratios

This is one thing you definitely need to pay attention to if you’re investing your money in investments that get “managed.” This includes everything from robo-advisors to traditional bank mutual funds and everything in between.

Pretty much anything other than buying individual stocks on your own, and managing your portfolio yourself, will have a management expense ratio. That ratio – which is almost always referred to as an MER – is a percentage, and it represents the percentage of your invested assets (ahem, your money) that you pay every year to the people who are managing it.

So why does MER matter so much?

Since your MER is a percentage, it can seem laughably small. I mean, what’s two percent, really? I wouldn’t even bother buying something that was on sale for two percent off, because it seems like such a tiny number. But when it comes to your investments, that two percent might represent hundreds of thousands of dollars in fees over your lifetime. Seriously.

"That’s because over time, your investments will grow."

That’s because over time, your investments will grow. Two percent seems like a small fee when you’re investing $1,000 — that’s because it is. With an MER of two percent, and $1,000 invested, you’ll pay just $20 over the year to invest your money. Seems fine, right

Well, when your investments eventually grow to $100,000, that $20 fee will have ballooned to $2,000 a year. And if you keep going and hit the $500,000 level? You’ll be paying $10,000 a year to keep your money invested with a two percent MER.

Yikes.

There’s also the issue of compounding. The reason investments are so great for your money is compounding interest. Basically, if your investments grow by 10 percent every year, you keep that growth – and you earn even more interest on your total balance the next year. It creates a snowball effect that can mean a huge amount more money over the course of your lifetime.

But a high MER cuts way down on the amount of money you’ll end up with, because those fees compound, too. Over time, they leave you with less money, and the gap between your low-fee and high-fee investments grows and grows.

So bottom line, what’s a decent MER?

There’s no hard-and-fast rule to what makes for a good, affordable MER, and since people likely aren’t going to manage your money out of the good of their hearts, it’s something you can expect to find in just about any managed investment situation.

That said, if you’re looking to keep your costs down, there are many index funds and robo-advisors that offer MERs way below one percent. They can do that, because they take a passive approach to investing, and they just try to match the market – not beat it. If you’re not paying someone to actively pick stocks and funds for you, under one percent is a fair price.

If you’re rocking a more complex money situation, it might be worth paying more than one percent, but only if you’re getting real, tangible value out of it at the same time. There are tons of great financial advisors who will charge you a percentage of your invested assets to manage your money, and they’ll help you create a financial plan too. If you need help with planning, a higher MER might be worth it.

Ok, so that’s MER. What’s this AUM business?

Well, if MER is how you get charged for your investments, AUM is the why.

Let’s put it this way: If you’re paying an investment advisor or a mutual fund company based on a percentage of the money you have invested with them, then part or all of their business model is based on assets under management. That’s AUM.

They make money based on the amount of money you invest with them at any given time. If you decided to pull all of your money out of the stock market, and hold it in cash? They make $0 if they’re entirely based on the AUM model.

It’s important to understand this side of the investment management business because when you understand how companies make money, you can start to identify where there might be conflicts of interest.

Let’s say you’re saving up for a house downpayment in a few years and you’re keeping that money in a high-interest savings account. If you’re getting advice from someone who makes their money in an AUM-type situation, they make $0 on the money in your savings account.

See the conflict of interest? If they advise you to keep your money in a safe savings account, because you’ll need it in a few years to buy that house, they make $0. If they advise you to put it into the market, which is a riskier move, they make money.

Now, there are a lot of wonderful, ethical people who work in AUM environments who will give you advice that’s in your best interest. But whenever these conflicts of interest might arise, you need to be aware of them – because no one will care quite as much about your money as you do.

So what do I need to do?

MER and AUM are facts of life in the investment management industry, and they won’t be going away anytime soon. Now that you know what they are, and what they mean for your money, you’re equipped to ask the right questions – and the tough questions – to make sure you’re paying a reasonable amount for the services you’re getting.

 

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Posted 01.10.2017 - 03:02 pm EST