Derek, can you explain the different types of investment fees?
Understanding how much you pay in fees should be an important part of your investment plan. The truth of the matter is that investment advisers don’t work for free, so it is best to be aware of their total cost and the value they bring to your financial picture. Fees shouldn’t be your only focus, but they are a consideration.
For those who invest with an adviser you may have a fee-based account, or a transactional account.
A fee-based account means that you and your adviser have an arrangement whereby there is a fee charged to the account that is a percentage based on the total assets in the account itself. In this arrangement, the costs are obvious as you can see them on your statements.
Because the fee is visible, it may even be tax-deductible. The fee normally covers all costs to buy and sell securities and there are usually no other costs for operating the account.
Advisers who operate under a fee-based structure may offer a full suite of other services including financial planning, insurance advice, and will and estate review. Your percentage based fee normally includes access to these services.
In fee-based accounts the costs are intended to be fully visible so that you’re aware of the true cost of the advice you are receiving and the investment you are in. The cost depends on a number of factors including the services your adviser offers and the size of your accounts, but may fall somewhere between 1-2 per cent annually.
The other type of account structure is transactional. This is a structure whereby your adviser charges for every transaction, or, receives an embedded commission referred to as a trailer.
In a transactional account, if you wish to buy or sell stocks or bonds, your advisor may charge you a percentage of the value of the trade. Usually, the percentage declines as the dollar amount of the trade increases.
This percentage varies with advisor, but may fall between 2.75% to 1% per transaction.
If you’re buying mutual funds in a transactional account you normally will have an internal fee. This is the same whether it is through with your advisor or your local bank. An internal fee means you don’t see a direct cost, it is simply deducted from your returns. For example if a mutual fund has a 2% internal cost, and you see that your mutual fund increased by 7% last year, it actually made 9% and the fee was deducted.
The fee on a mutual fund is called a management expense ratio (MER) and normally includes the cost of managing the fund and any trailer fee. The trailer fee represents the commissions collected by your advisor which is usually 1% of the value of your investment. So in the example of a 2% MER, 1% goes to the mutual fund company to manage the investment, the other 1% goes to your advisor.
Mutual funds can also have additional fees, such as a front-end load, or a deferred sales charge.
In the case of a front-end load, your advisor charges you an extra percentage to buy the mutual fund, but nothing to sell it; along with this charge your advisor continues to receive the annual trailer.
In the case of a deferred sales charge, your advisor charges you nothing to buy the fund, but receives a large one-time commission from the mutual fund company. The advisor normally forfeits part of the annual trailer to get this large upfront commission. When the investor sells the fund, the investor may have to pay a large part of that commission back – however, the advisor doesn’t have to pay back their commission.
As I’ve pointed out, your investment fees may not be straightforward. There can be numerous factors that can differ from what this information pointed out. The point however is that investors should have a good understanding of the fees they are paying. If you’re not sure, perhaps it’s time to have a discussion with your advisor about the true cost of your investment.
Lastly, fees are an important part of investing, but they shouldn’t be the only focus. Determine whether the fees you pay are in-line with the quality of the advice and service you’re receiving. Just as most things in life prove, cheaper isn’t always better.
Wealth Watch is written by Derek Fuchs, a wealth advisor with ScotiaMcLeod in Red Deer. It is provided for informational purposes only and any opinions contained in it are his own. Readers are urged to consult a wealth advisor for help with their personal investment circumstances. Fuchs can be contacted at firstname.lastname@example.org.