Do you know how much you’re paying your financial advisor?
If you don’t, you’re not alone. Figuring out just how much you are paying isn’t straight-forward. Despite regulation that attempts to force transparency, fees remain a mystery for many clients of financial advisors. * This is hugely unfortunate for clients (and fortunate for advisors) for two reasons: fees are sometimes higher than they need to be and advisors don’t always provide the level of service, advice and performance that clients deserve.
You should sit up and pay attention. You need to figure out how much you are paying every year. You might be paying thousands of dollars and be unaware. Finding the answers require a little sleuthing.
Every year, your financial advisor (let’s call them Pat, who works for Big Bank) is required to send you a statement outlining the fees they received for managing your portfolio. When you get one of these, you should read it and make sure you understand it. Why? It will also tell you (partly) how much you are paying and it can give you insight into Pat’s incentives.
The report you’re looking for will probably be sent out at year-end and is called something like “Annual Charges and Compensation Report.” There are two sections to this report. One section outlines the fees you paid to Big Bank – this is the amount that comes out of your account. This may include advisory fees, trading commissions, and administration fees. The other section shows amounts that Pat received from third parties during the year – this can include trailing commissions on mutual funds and commissions for selling GICs. Add these two items together and you’ll see how much Pat and their firm was paid for the year.
What this report does not tell you how much you paid in fees for the year because it doesn’t show you the fees that you paid to the mutual fund companies. If you owned a mutual fund, you paid a fee called the MER. This can be a big component of the fees you pay if you have a substantial amount of money invested in mutual funds. You’ll need to estimate this yourself (and it’s just an estimate) by multiplying the MER on the fund by the amount you have invested in it. (You could also ask your advisor to give you an estimate.) Here is an example of what the fees might look like.
Now you have two figures: what your advisor earned and what you paid. If you own a mutual fund or even GICs, these two numbers won't be the same. In fact, you're paying more than they are getting. Why? Because the fees you are charged on the mutual fund pays for two things: 1. the trailing commission your advisor gets (yup, it's just a round-about way of paying your advisor) and 2. the management of the fund by the fund company. This is why mutual funds often have high fees when you buy through an advisor.
Now that you have these two numbers, you have to ask yourself two questions.
Question 1: Am I being sold a mutual fund when there’s another investment that’s less expensive and could do the same or better for me?
If your advisor received a big chunk of money from third parties in the form of a trailing commission, you need to look closely at the mutual funds you own. Here’s why: The mutual fund industry uses trailing commissions as incentives to get advisors to put their clients’ money into mutual funds. A trailer fee or trailing commission is money paid to the advisor – it’s often 1% per year. This means your advisor gets paid 1% of the amount you have invested in the fund for as long as your money remains there. For example, if your advisor put $80,000 of your money into a fund with a 1% trailing commission, they will be paid about $800 a year (roughly).
Why should this worry you? If Pat gets a trailing commission to put you into a mutual fund but gets nothing to put you in an ETF, chances are decent you’ll get the mutual fund. You’ll pay a high MER for a product that is not necessary – you can accomplish your objectives with ETFs and index funds. So remember: large trailing commission = big fees for you. ** You should be asking your advisor about why you own this fund instead of a cheaper option.
Question 2: Am I getting good advice and service for the fees I'm paying?
Now that you’ve seen in dollars how much you are paying in, it’s time to think about the level of service and quality of advice you’ve been receiving. You should consider things like how often you hear from your advisor, how much time they take to explain your portfolio to you, how responsive they are when you call or email about something, whether they’ve offered you any financial planning services like a retirement plan, and how much assistance they are giving you with things like RRSP and TFSA contributions, RRIF withdrawals and so on.
And of course, you must look at the performance of your investments. Every year, you’ll get a report showing your returns over the past year, and over the longer term. Are these long-term returns in line with what you should expect given the kind of portfolio you have? How do they compare to the expected returns your advisor discussed with you at the outset? (I acknowledge you might not know this – see the post-script for help on this.) If your returns are lacklustre, see if your advisor has a good explanation. (For example, maybe you asked for a dividend-paying portfolio which has left you improperly diversified at a time when these stocks have done poorly.) If they bumble through without a clear explanation, use excessive financial jargon, or sidestep the question, you should be concerned.
Now what?
If you determine that the fees you are paying aren’t making you feel good, now what? You have a few options. The first is to talk to your advisor about lowering your fees. Ask if they can use ETFs or index mutual funds instead of regular mutual funds. Or try negotiating a lower percentage advisory fee. You could also shop around for another advisor, asking about their fees and whether they offer ETFs instead of mutual funds. If you make it clear that you don’t want any expensive mutual funds, you might find someone who will agree to that, especially if they are a fee-based advisor. And of course, you can take your money and manage it all yourself or use a robo-advisor – it’s not for everyone, but it’s certainly an option.
* A financial advisor manages money for people and is not the same as a financial planner, who does much more than just managing money (if they do it at all).
**Note that not all advisors charge this way. Fee-based advisors charge you a percentage of the assets you have with the advisor, regardless of what you’re invested in. With this arrangement, your advisor receives no trailing commission because you are paying them directly. This is a more transparent fee structure and eliminates the incentive for an advisor to recommend a mutual fund over a less expensive product.
How to figure out how much your portfolio should be earning
Figure out what percentage of your portfolio is invested in fixed income (bonds, GICs) and equities. This might not be easy to do if you own a “diversified” mutual fund – you will have to look at what the fund is invested in and extrapolate. Then, multiply the fixed income percentage by 3.4% and the equity percentage by 8% and add those numbers together, like this:
30% x 3.4% = 1.02%
70% x 8% = 5.6%
6.4% + 0.68% = 6.6%
With a portfolio of 30% fixed income and 70% stocks, you can expect to earn about 6.6% per year. Compare this to the 3-year, 5-year and 10-year returns to see how your financial advisor is doing for you.
Photo by Ryan Hutton on Unsplash.
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