If you want your money to be professionally managed, there is no escape from fees. The key thing is to be smart about getting the most out of paying the fees, to avoid paying more than necessary, and to line up your advisor’s interests with your own.
For those with mutual funds, it means leveraging your holdings to your advantage and that, in turn, requires that you know how mutual fund fees work.
The main fee levied by mutual funds is the management expense ratio (MER), which is automatically deducted. MERs can range anywhere from 1.5 to 3.0 per cent annually.
Most goes to pay the money managers and for administration, advertising and a trailer fee, either 0.5 per cent or 1.0 per cent, to the advisor.
The advisor gets the trailer fee for providing you with ongoing service and advice. So you should make sure you get the best possible access to financial planning information.
Aside from giving you great hints on tax and estate planning, the advisor should be updating you regularly on the performance of the fund, why it is still the best one to be in, and what the alternatives are doing.
If you are not getting this, don’t be shy; ask for it. If you still don’t get it, then consider moving to another advisor who you know, through references from others, will give high-quality service and advice. You should especially give this some attention if your funds are held where advisors are locked into recommending only certain mutual funds or appear to have little financial planning expertise.
In order to align the advisor’s interest with your own, it is also important to understand sales and redemption fees. In front-load funds, you may or may not pay a sales fee (often no more than 2 per cent) directly to the advisor when you buy, but you can sell the fund and go elsewhere anytime without paying redemption fees.
However, with back-load funds, while you pay no up-front commission, the advisor gets a 5 per cent commission directly from the fund company. But if you sell the fund, you must pay a redemption fee of 6 per cent, declining to zero by the sixth or seventh year.
The advisor gets a 1 per cent annual trailer fee for front-load or no-load funds and a 0.5 per cent fee for back-load funds (lower because he or she already was paid a sizeable commission from the fund company).
For investors, the back-load funds make absolutely no sense. As all experienced advisors know, investors have a psychological hang-up with paying the redemption fees associated from selling back-load funds and that usually means they stay with poorly performing funds long after they should have moved.
In addition, the lower trailer fees associated with the back-load funds mean advisors, who know their dollars and cents, have less of an incentive to provide good service and advice.
Your best bet is with front-load or no-load funds. These best align the advisor’s interests with your own, so that the key way the advisor benefits over the long run is if your assets increase in value.
With these funds, you can move whenever it makes investment sense and without the psychological trauma of paying redemption fees. Also, you don’t have to worry that the advisor is suggesting a move only to get the 5 per cent commission from putting you into a different back-load fund.
Another benefit is the advisor gets more compensation through a higher trailer fee and has more of an ongoing interest to keep you happy.
You shouldn’t have to pay sales commissions on buying new front-load funds. (By definition, there are no sales fees on non-load funds.) There are an increasing number of good advisors who work for only the 1 per cent trailer fees from front-load or no-load funds and let their clients switch funds without paying any sales commissions.
While some critics complain that MERs of 2.5 or 3 per cent are too high, there is an easy way to reduce fees overall for investors who have balanced portfolios. That would be to use mutual funds only for investing in equities and to invest in bonds directly.
Compared with stocks, particularly foreign stocks, bonds are relatively easy to do yourself, with the help of an investment advisor. You don’t need to pay 2.5 to 3 per cent a year to have your bonds managed in a balanced fund, or 1.5 to 2.5 per cent a year to have them managed in a bond fund.
Your advisor may not make this suggestion because it would mean giving up some of the associated trailer fees and would require more work.
So that leaves it up to you to insist upon this approach. With it, given that bonds usually make up 40 per cent of a balanced portfolio, you can bring the overall fees on your portfolio down to an average of around 1.5 per cent a year, which is in line with the level of portfolio management fees charged to high-net-worth investors with portfolios of $500,000 or more.
Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.
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©2003 Wayne Cheveldayoff