I shared some of my thoughts on fees in blog #5 when I discussed mutual and exchange traded funds, but they deserve some more attention as they can really detract from portfolio returns. I believe it’s really important to understand both the fee you are paying and the value you are receiving.
Value is important because it is so subjective. What’s important for one investor may be different for another. For example, if you want to make an investment without receiving any investment advice, you can make the trade on a do-it-yourself, low-fee platform. Conversely, if you would like comprehensive portfolio management and planning, you should expect to pay higher fees to establish and maintain an ongoing relationship with an advisor. What you want to avoid is paying fees without getting good value in return. So be clear on what you want or need and ask for it.
If you don’t know what to expect from a relationship with an advisor, here is what I believe is a realistic minimum ask:
- Access to your advisor to discuss your financial situation and regular reporting on your portfolio’s performance.
- A financial plan so you can see the big picture and get retirement, estate and tax planning advice.
- A customized investment plan that optimizes the portfolio’s tax efficiency.
- Regular portfolio rebalancing to maintain your asset allocation and desired risk profile.
I also believe other services such as year-end tax loss harvesting and access to in-house accountants and lawyers for advanced planning strategies are also very valuable.
What you should expect to pay by way of fees should be based on the services you need AND receive. There are two main ways that advisors charge fees and that is on either a commission or fee basis. In a commission account, a fee is typically charged when an investment is purchased. The size of the fee is based on the size of the transaction (fee should go down as size goes up). If you are buying an individual stock, bond, or exchange traded fund, then the commission will be charged on the buy and sell.
Some advisors charge a commission to buy a mutual fund which is called a front-end load (FE) (eg. 2% of the amount that you are buying is added to the cost of the fund). Some advisors choose to buy a low-load (LL) or deferred sales charge (DSC) fund because, the burden of the up-front commission is shifted from you (the investor) to the mutual fund company. The catch is that the mutual fund company won’t allow you to sell out of that fund for a period of time without paying a hefty penalty (typically 3 years for a LL and 7 years for a DSC fund). The fund company locks you in because they want to recover what they paid the advisor. I don’t believe it’s good to be locked in to any investment as one never knows what the future holds so be careful about LL and DSC funds. Keep in mind that mutual funds also charge an ongoing fee to manage the fund which is called an MER (management expense ratio). Part of the MER is paid to the advisor’s firm as an ongoing incentive to keep the fund and is called a trailer. If you are a buy and hold investor, a commission-based account may be the most suitable for you.
Fee-based accounts are much more mainstream and popular today than in the past. With fee-based accounts, a percentage fee is charged on the portfolio which is typically calculated based on the month end balance and paid from the account on a monthly or quarterly basis. For the fee, you receive either a set amount of trades or unlimited trades (with discretionary managed accounts). This type of account is ideal for actively traded accounts and for accounts that are regularly rebalanced (see blog #14). Finally, there is some added incentive for the firm with fee-based accounts because if the account value goes up then both the investor and firm will benefit, but more importantly for the investor, if the account goes down the fee will drop as well.
A question that I often get is, “Am I paying two fees, (the MER and the fee on the account), if there are mutual funds in a fee-based account?”. Just as there are different fund codes for commission-based accounts (FE, LL, DSC) there are F class funds for fee-based accounts. In a fee based (F) fund, the trailer is taken out to account for the fee charged on the account. For example, if a fund in a commission account has an MER of 2.5%, an F class fund with the trailer out would reduce it to a 1.5% MER. If the fee on the account is 1%, then the total charged would be 2.5% (same as the commission account). Here’s one key difference. If the account is non-registered then you would be able to deduct the account fee of 1% so you can save some tax dollars there!
Just like when you go to an accountant or lawyer and pay a fee for their advice, you should expect to pay a fee for financial advice. Just make sure you know what it is and what you are receiving for it.