Nope, I’m not going to discuss the next Star Wars Movie and hope that R2D2 will be part of it; I will discuss the impact of the no-media-attention-event of CRM2 or Customer Relationship Model Stage 2. For the past couple of years, the Canadian Government has deployed efforts to provide more financial information with regards to investment management fees (known as MERs) charged to clients by investing firms. If you read a couple of investing blogs, you are probably aware that management fees in Canada are ridiculously high. Worse than that; most of fees are semi-hidden in the 34th pages of a 120 page document so the firm is sure the investors will always be half-conscious of what he is really paying. You don’t believe me? Try this at work:
Ask your colleagues if they know how much they pay per year to their financial advisor to manage their funds.
Half of them will give you an approximation and the other half has no clue. Unfortunately, this is not a sexy topic so there isn’t much media coverage in the financial industry at the moment. Is it because it sells more copy to tell people the market is going to crash? Or is it powerful investment firms who warned the media to not spoil the story? I’ll let the conspiracy theory fans to go on that rant, and I’ll just get back to what CRM2 will change if you are Canadian.
A Clear Understanding of your Fees
As of July 2016 (next year), management fees will have to be disclosed in a clear and obvious way for all investing firms. For a reason I’ll ignore for now, insurance companies selling funds are not hit by this law… yet. For the rest, your investment statement will clearly post how much you pay to your advisor (and his firm) to manage your nest egg.
If you deal with a broker and he charges a base fee on your assets, you won’t see much difference.
If you invest with banks and their mutual funds, you will see their fees on the first page of your statement.
But if you invest with an independent, you will see all kinds of fees such as trailer fees, buying fees, selling fees, etc.)
This is really good news for any investor, as some will soon realize how much they truly pay. Be prepared to be scared as you might be paying between 2 and 2.5% (even 3%!) on some funds. If you have a $250,000 portfolio, this means it costs you between $5,000 and $7,500 annually.
Is it that expensive? Are you REALLY getting RIPPED OFF by your advisor?
ETF fans will tell you there are no worse things in the world (maybe besides sour milk in your Starbuck’s coffee) than mutual funds due to their “ridiculously” high MERs. According to them, investing firms are simply and clearly stealing money directly from your pockets for absolutely no justifiable reason.
As a DIY dividend investor myself, I can’t tell you investing in mutual funds is cheap. In some cases, it is clearly stealing. But overall, I think paying MERs on mutual funds is a good thing. Keep reading and you’ll understand why. I’ve had this discussion many times with friends of mine and came up with the perfect analogy.
You have to pay to take care of something you don’t know
I’ll be honest; I have no mechanical background and absolutely no interest in knowing how my car works. As long as it starts in the morning and gets me to where I want to go, I’m pretty happy. But consider this: over the course of a typical year, I probably pay around $1,000 in basic car maintenance such as brake cleaning, oil changes, winter/summer tire change, etc. All these things could/should easily be done with minimal knowledge. If I consider my car worth $30,000, this is a “MER” of 3.33% on an ever-depreciating asset. I’ll never make money with my car, and worse, I’m paying a high fee to keep it running. I could save that $1,000 easily. Any mechanic would tell me I shouldn’t pay $150 to clean my brakes. But you know what? I pay because I have no clue and no interest in learning how to do it.
If one morning, I wake up with the stupid idea of taking care of my car myself, I could probably do more damage than good since I don’t know what I am doing. Over the years, I’ve noticed many investors who don’t know what they are doing and are better off paying fees to have a professional manage their money.
Does it mean you should pay 2.5% to your advisor? I don’t think so.
Does it mean your advisor should only invest your money and review your portfolio with you once in a while? I don’t think so.
What you should be paying for
The investing world is quite vast for the neophyte and this is why it is important to ask the right question to your advisor. Through his answers, you will be in a better position to see if you are paying for something in returns. Here’s a quick list of point to discuss with him:
How your advisor earns his money
Some are paid bi-weekly by their firm (usually banks) with a bonus at the end of the year. Others are fee based meaning they will charge you per hour or task such as an accountant would do. These are pretty much not biased by level of expense. You will also find commission based advisors that don’t make money if you don’t invest with them. This is no perfect world and no best way for a client. The important thing is to know how the guy who’s giving you advice is compensated and to understand where the advice is coming from.
Ask about your financial advisor’s background
Some of them have a trading license and that’s about it (for the record, the fund license takes about 2 months to get for someone who is ready to study hard). Others have a bachelor degree, a master degree and/or a professional title (such as CFA, CFP, etc). Some are fresh out of school and others have seen interest rates over 20% in the early 80s. A good discussion will tell you if your advisor knows more about the market than you do.
Why does he offer you this or that fund instead of another
The point here is to know if he gets a better commission from one fund or another. He should be able to explain why he chose this investment vehicle. Ask him a few options to compare. You will see how knowledgeable he is of his own industry or if he keeps selling the same koolaid to all his clients.
What are you getting from your advisor besides an investment account
Some advisors will simply invest your money and won’t do much else. Others will offer to revise your personal financial structure and provide you with advice on tax optimization, debt restructurating, financial, estate, and insurance planning as well as banking information, etc. If you have an advisor able to provide you with several points of advice like this, your MER become really cheap!
Can you get a rebate if you bring more assets in?
You can’t negotiate all kinds of MERs (mutual funds fees are pretty much non-negotiable) but as you bring more money to the table, your advisor should be able to find investing solutions that offer lower fees. For example, it doesn’t make sense you pay the same thing for a $150,000 portfolio than the beginner with $2,000 in hand.
Don’t expect to beat the index, but rather follow your investing plan
The point of investing in mutual funds is not to beat the index. Most managers don’t make it over 5 – 10 years because MERs drag down their performance. However, the real purpose of buying mutual funds is to smoothen out your overall returns year after year and to avoid dropping like a rock when the market is down 30%. Find an advisor that will come up with a financial plan and make it your goal to follow this plan instead of outperforming the market. 4-5% returns is often enough to build a comfortable nest egg.
Final thoughts on Fees
I don’t see myself paying for such fees because I know (and most importantly I LIKE) how investing works. This is why I manage my own portfolio and I’m pretty sure most of my readers are the same. However, if you don’t have the time, the will or the knowledge, there isn’t anything wrong with paying someone else to do it. At that point, it’s more a matter of how much you pay to get the job done and what kind of job is done for you!
Have you had any good or bad experiences with your financial advisor?
Nice topic and nicely explained.
Like you said, the message is not out there yet, and probably for the most part won’t be understood for some time even when it’s printed on your statement.
The disclosure unfortunately also will not apply to Group Company pension plans.
I’m not sure your car example is a good one. When it comes to “active investing”, I believe over the long term, the figure is 85% of advisors don’t beat index investing… (something close to that)
Yes, it may make sense to pay a higher fee to that 15% that do. But how does one find that 15% group. Good friggin luck. You don’t know until it’s too late.
I’ll give you another example. We just switched our “broker of record” for the DC company pension plan at my work. Simply by swapping one broker out for another we saved an average 42% in MER’s without changing a single fund. They simply negotiated a better deal with the major fund companies and charged a reasonable MER. What does that tell you about the “value” of an MER? It speaks volumes to me.
I do however agree totally if you get that guy who can do it all for you and will take the time as part of his payment through his commissions he receives through fee’s (not additionally) then possibly his payment is justified.
Still there is no justification to lose over 30% or more of your growth over a lifetime of MF investing to fees. A high 1% or more fee can easily do that to you. It’s the silent killer of returns. Nothing changes the fact that a 2.4% MER on a $300,000 MF will take $7200.00 a year away from you. Particularly in flat or down years. This is simply robbery.
Hello Paul,
Thx for your comment!
The car analogy is not perfect, but I think people should not pay an advisor to beat the market. Stats have shown that profession portfolio managers don’t by the index over 5 years (in fact, only 5% does, it’s even worse than the 15% you thought).
However, it is also a fact that most people don’t know what they do when they invest. It’s like giving a gun to a child; it will eventually comes down to a disaster.
How many people sold their investment back in 2008? This was the worst timing ever to sold. Nonetheless, economic stats show a massive equity fund/etf sold to see the money moved to bonds funds and etf. A good advisor would not allow his client to do that. He would explain why one should not sell during the time and explain what is going on the market. This advice alone worth 30% of your nest egg right there. This is for the kind of advice investor should pay for.
You probably don’t need such advice as you probably didn’t sell back in 2008. This is because you understand what you do when you invest and you are not a child holding a gun.
I agree with you that if you have a 300K portfolio, your MER should definitely be below 2%. But then again, if you only pay your advisor to beat the market, you pay him for nothing and you are wasting your money. A financial advisor must bring a lot more on the table than simply opening a mutual fund account and cash the MER!
Cheers
Mike.