Later this fall, the Canadian Securities Administrators will be publishing for comment ideas that will likely eventually eliminate the embedded trailing commissions related to mutual fund investments. What is this, and why is it important?
Well, if you weren’t aware of it already, a component of the mutual fund fees you pay today go to the advisor and their dealer, so as to provide to you the service and advice you may wish to have from your advisor. More specifically (using round figures), if the management fee on the mutual fund you own is 2.50%, and if this money is invested on a front end loaded basis, then typically 1% of this amount is paid to the dealer and 1.5% is retained by the mutual fund company to cover their portfolio management and product distribution costs. The 1% portion paid to the dealer of the advisor may result in one quarter of this amount being retained by the mutual fund dealer and three quarters of this amount paid to the advisor. Of the amount paid to the dealer and the advisor, other costs are paid out of these amounts, such as rent, salaries and technology.
Here’s an example, if you had $100,000 invested in a mutual fund, $2,500 (2.5%) would disappear in management fees. Of this amount, approximately $250 would be paid to the mutual fund dealer firm, who is responsible for sending you an annual statement as well as providing supervision and oversight of the mutual fund advisor. $750 of this amount would be paid to the advisor, who then may see half of this amount go toward covering their own office overhead. When you look at it this way, of the $2,500 in fees that you pay, about $375 of this amount goes to the advisor to cover the time they spend with you, providing advice and guidance.
The knock on these fees is how they can add up over time. For example, if you had a $500,000 portfolio in mutual funds, a 2.5% management fee represents $12,500. If you paid this same amount over the next 20 years, this adds up to $250,000 in fees paid (assuming the portfolio didn’t grow in value). The argument is that these fees can harm the longer term growth of your portfolio. Is this accurate? Sure it is.
But now let’s look at this another way. In this first example, the portion of the fee that can be linked to the take home income of the advisor is approximately $375-$600 per year. In the second example, this amount would be in the $2,500-$3,000 range (after the overhead of the advisor is considered). If we then applied a reasonable hourly rate for professional services ($250 per hour), then the first example would represent 2 to 3 hours of time per year, while the second example represents 10 to 12 hours per year of time the advisor would potentially spend with the client, or on behalf of the client, providing professional services.
I appreciate that many of you reading this article may quarrel with my figures. You may question whether an advisor is worth $250 per hour or you may question the overhead costs of the advisors operation. You may also question the number of hours the advisor may actually spend overseeing your portfolio, meeting with you directly or providing specific financial advice.
With these thoughts in mind, here’s my question to you. If we do enter a world where “advice” becomes unbundled from the product, what are you prepared to pay for this advice? Are you prepared to pay a monthly retainer fee to your advisor so your cost could be paid over time? Are you prepared to pay a fee of $1,000-$5,000 for a well written financial plan?
I think these questions are important ones to ask in this time of change.
For the record, I, as a consumer, much prefer to pay professional services as they are incurred. However, I also appreciate that a financial advisor may do more for me in behind the scenes than what I am aware of. This means that there will always likely need to be some fees paid along the way each month.
Many people are already paying many hundreds or thousands of dollars for professional advice each year, but are not aware that they are doing this through their mutual fund management fees. If the advisor compensation portion is removed from these funds, then the consumer will have to pay their advisor in a different manner or not work with any advisor at all. For some this may be fine, but for others, this change may be a hardship.
And so I reflect on this question. How much are you prepared to pay for expert advice as it relates to your personal situation?