The lesson that costs matter has long been articulated by indexing evangelists in the United States, such as John Bogle, chairman of Vanguard Group Inc.

But it is only in the past two years that the Canadian investing public has awakened to the long-term impact of high MERs on their investment returns. Actuaries like Malcolm Hamilton of William M. Mercer Ltd. in Toronto and Fred Thompson of Thompson Actuarial Ltd. in Singhampton, Ont. have shown that the average MER of 2.1% curtails registered retirement savings plan returns by 47 percentage points over 30 years (compared with the unattainable MER of zero.)

However, a passively managed index fund with an MER of 0.45% reduces returns by only 12.7 percentage points over 30 years, while a fund with a stingy 0.25% MER exerts a minuscule performance drop of just 7.2 percentage points over the same period.

Low-MER, no-load index funds have been a popular discussion topic on the Fund Library's Internet site. Bylo Selhi (a telltale pen name of one contributor to the site) is a passionate advocate of do-it-yourself, passive investing.

Mr. Selhi also refers to Mr. Hamilton's "Rule of 40." As Mr. Hamilton describes it: "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."

More precisely, after n years the percentage of your money you get to keep is:

That's the case for large-capitalization funds, but frictional costs like commissions, delays and missed trades can be as high as 4% on small-cap funds.

And outside an RRSP or registered retirement income fund, the taxman inflicts further pain. The U.S. government recently launched the Mutual Fund Tax Awareness Act of 1999 (see: Vanguard backs the Mutual Fund Tax Awareness Act of 1999.) Vanguard says the average domestic [U.S.} equity mutual fund has lost almost 2.5 percentage points a year to taxes on distributions of dividends and capital gains made to fundholders in the past 10 years.

For Canadians "that's conservative, considering our capital gains tax rate is double what Americans pay," Mr. Selhi says.

Banks and direct seller Altamira Investment Services Inc. have responded with gusto to the MER challenge. For one brief moment, Scudder Canada Investor Services Ltd. led the charge, but its move to a broker-sold outfit, Scudder Maxxum Co., seems to have blunted its appetite.

The Canadian fund industry seems to be split seems to be split on the issue. The broker-sold camp continues to espouse the benefits of active management and have, if anything, raised MERs by introducing such products as life insurance-based guarantees and RRSP-eligible foreign funds.

Meanwhile, the banks are pushing passive investing with low-MER funds. The magic number that defines a low MER has dipped below half a percentage point (50 basis points) -- or one-quarter of the average Canadian funds' MER of 2.1%.

A few weeks ago, Toronto-Dominion Bank threw down the gauntlet with its new "e-Funds." Green Line Canadian Index e-Fund and a U.S. Index e-fund both sport MERs of 0.29%. The same index funds bought at a branch or through brokers have MERs of 0.8% to 0.9%.

Royal Bank of Canada cut MERs on two funds to 0.28% [for investments of more than $250,000 per fund--ed.] Both Royal and Canadian Imperial Bank of Commerce are considering selling index funds online. CIBC has a 0.3% MER on an index fund account with $150,000 in assets and 0.25% on a $500,000 account.

True, such MERs are still higher than the 0.18% of Vanguard's U.S. index fund. And index participation units have a negligible 0.05% MER.

See also: Low-MER No-Load Index Funds Available in Canada