Here’s a question I hope you asked your financial advisor when you were setting up your portfolio: “What am I paying for these services, and how does my advisor get paid?”
If you don’t know the answer to that question, you are not able to assess whether you are getting value in proportion to what you are paying. For the purposes of this article, we will focus on fees relating to mutual funds.
What do you, the client, pay?
In short, you pay the sum of the MER and the TER:
- Management Expense Ratio (MER) is comprised largely of the management fee, plus other costs associated with the fund (marketing, etc.). In Canada, the median fund fee is around 2.32% (source: Morningstar Inc., Dec. 31, 2015).
- Trading Expense Ratio (TER) reflects annual costs incurred by the buying and selling of the securities within the fund. In general, more trading activity results in higher costs.
How is your advisor paid?
Historically speaking, a commission-based model has been the most common method for advisors to be compensated. This is paid whenever an investment in a ‘load’ fund is bought for a client (whether or not you actually receive advice). The mutual fund company pays this commission to the advisor. Although you don’t technically pay anything out of pocket, your MER is higher and, if you sell the investment within a certain time frame (usually 5-7 years), you will pay a back-end penalty. In addition to the upfront commission, the advisor will also receive a trailing commission for as long as they manage that investment for you.
Asset-based compensation is another way that advisors can be paid, and it is becoming more common. It generally takes two forms:
- Advisors can use ‘load’ funds and forego the upfront commission. Instead, they receive a higher trail fee, which is paid to the advisor based on the amount of assets they manage on your behalf. These fees, like the commissions described above, are embedded in the MER, making them feel invisible. Investors are advised to read the fund prospectus, where these fees are explained.
- The other method of asset-based compensation is a fee-based model where the advisor compensation is ‘unbundled’ from the MER. Typically, advisors charge a fee of 0.5% - 1.5% based on the value of assets they manage on your behalf. This fee is separated from the MER of the funds in which they have invested your assets, and these will be ‘no load’ funds.
So, what is best for me the investor?
Most mutual funds are available using either of the structures described above. For example, mutual fund XYZ would be the same fund in either of the three scenarios described above—it would just be offered as a different class (Class A, F, etc.), each having a different MER.
The way your advisor gets paid can impact your investing costs. A commission structure or asset-based compensation using ‘load’ funds will generally involve a higher MER, typically at or above the average mutual fund MER. In a fee-based arrangement, your cost is the advisor fee plus the MER. Fee-based advisors typically use funds that have an MER of between 0.4% − 0.7%, which can result in lower overall costs.
In a fee-based model, you will see what costs you are paying. In the other models, although the fees are less noticeable because they are embedded, rest assured, you are paying them! (The Investor Education Fund has a fee calculator on its website, found at this link.)
The bottom line is to ask your advisor what you are paying in fees—the fees you pay impact the returns on your investment.
Jason Sirman is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. The information mentioned in this article is for general information only. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the prospectus and consult your Assante Advisor before investing. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and is registered with the Investment Industry Regulatory Organization of Canada.