Is financial advice free? Never.
But a lot of Canadians have been led to believe it is.
According to a 2017 study conducted by Credo Consulting, 62% of Canadians don’t believe they pay their Financial Advisor any fees at all. There’s an explanation for this astounding finding; until very recently there hasn’t been a requirement for Financial Advisors or their firms to let clients know how they're paying , or how much they're paying for financial advice. For years, fees have been hidden from most consumers.
In January 2017 major regulatory changes to fee disclosure were introduced under the Client Relationship Model II (CRM2). These new rules require investment dealers to disclose the fees you pay, in dollar terms, as well as the performance of your investments on monthly, quarterly and annual statements.
If you're investing through a life insurance company, the new CRM2 rules don’t apply. Some Insurance Agents who brand themselves as 'Financial Advisors' continue to perpetuate the ‘no fee’ myth. We found just such an example where an Insurance Agent claims: “No Fee For Service – We have made the deliberate decision to not charge fees for our services.” Ironically, if your 'Financial Advisor' is an Insurance Agent - it's likely that you're paying fees that are much higher than the average Canadian. This is because one of the only products Insurance Agents can recommend for investment purposes (for your RRSP or TFSA for example) are Segregated Funds. These are insurance contracts which resemble mutual funds but carry management fees (fees you pay) which are on average over 3%, and sometimes as much as 4% per year – substantially higher than your average equity mutual fund fee of ~2.2%.
In spite of the historical lack of fee transparency which has characterized much of the financial services industry, it’s difficult to understand why so many Canadians remain in the dark. Especially given the effort investor advocates have put into highlighting the impact of fees on long term portfolio performance.
In order to make a clear assessment of the value of the services received from an Advisor you need to know;
- how fees are calculated;
- how much these fees are, and;
- if there are any fees not being disclosed.
How you pay your advisory fees is largely dependent on a few different factors: the investment dealer they work for, their registration category, their regulator, and their service offering.
Different categories of Advisors and their Fees.
Portfolio Managers (PMs) are paid a fee which is calculated as a percentage of the assets they manage for you. For example, if you have $500,000.00 with a PM and your fee is 1% - your annual fee will be $5000.00. This fee is charged either monthly or quarterly and deducted directly from your investment account. A fee schedule will typically show fees decreasing as client assets increase.
Portfolio Managers can be registered with either the Investment Industry Regulatory Organization of Canada (IIROC), or any number of Provincial Securities Commissions, such as the Ontario Securities Commissions (OSC).
There is an important distinction between PMs who are registered with IIROC and those who are registered with Provincial Securities Commissions.
PMs and Dealers registered with Provincial Securities Commissions - firms such as High Rock, Bridgeport, TriVest, and Lowrie Financial - are required to work under a Fee Only compensation model.
PMs whose firms are registered with IIROC - larger dealers such as HollisWealth, Canaccord Genuity, and the ‘bank owned dealers’ such as RBC Dominion Securities or Scotia McLeod – are able to work under either a Fee Based or a Fee Only compensation model.
Fee Only – These advisors are compensated directly by their clients – they are not able to accept commissions or other payments for selling specific products. Fee-Only Financial Advisors may charge their fee as a percentage of assets managed, or as a flat fee. In other instances these fees may be charged as an hourly rate, on a project basis, or on retainer. Because a Fee-Only model removes the potential for conflicts of interests and is completely transparent, this compensation model is considered the gold standard of the industry.
Fee Based – When an advisor is fee based they may charge fees as well as commissions and/or trailing commissions based on the products they sell. Fee based advisors are not committed to one transparent fee for all their clients and their method of compensation may vary from client to client.
Mutual Fund Advisors
Roughly two thirds (80,000+) of all Financial Advisors in Canada are only licensed to sell Mutual Funds. With very few exceptions, Mutual Fund Advisors are compensated by way of ‘embedded commissions’, which is really just a polite way of saying ‘hidden fees’. These embedded commissions are also known as trailer fees and form part of a Mutual Funds total Management Expense Ratio (MER). If you hold mutual funds in your RRSP account, for example, the company that manages your mutual fund holding will take their fee from your fund every month. The fund company carves off a portion of this fee – the trailer - which is shared by the dealer and your Financial Advisor. Prior to the implementation of CRM2, mutual fund investors were not told when this fee was being taken or how much was being taken.
This appalling lack of client disclosure was supposed to be cleared up with the implementation of CRM2 in January of 2017. However, the new rules only require investment dealers to report the “trailer fees” paid to your Advisor – not the total Management Expense Ratio, which includes the much larger management fee paid to the mutual fund company. This means that at least half of the fees being paid by mutual fund investors are not being report in dollar terms on statements. According to the Investment Funds Institute of Canada, as of December 31st , 2018, we as a nation had almost $1.6 trillion invested in mutual funds, representing 38% of Canadians’ wealth. With an average all in fee of just over 2% on Mutual Funds, Canadian are paying somewhere in the range of $20 to $30 billion in fees every year for their mutual funds - leaving billions in fees that are not being properly disclosed.
Broadly, there are three ways clients pay their Mutual Fund Advisor – in each case fees are dependent on the ‘class’ or 'series' of mutual fund your Advisor recommends you purchase – there are three standard mutual fund sales charges:
- Deferred Sales Charge (DSC);
- Front End Load (FE), or;
Deferred Sales Charge (DSC) – sometimes referred to as a Back-End Load – DSC’s are the least desirable form of compensation from the client perspective. A proposed ban by regulators has recently been contested by the Ontario government. Many Dealers have taken matters into their own hands – going so far as forbidding their advisors from recommending DSC funds. Compensation on a DSC fund has two components. When an Advisor sells a DSC fund to you the mutual fund company pays an immediate 5% commission to the Advisor’s Dealer. A $100,000.00 purchase, for example, would result in a $5,000.00 up front fee split between the Advisor and the Dealer. An additional ‘trailer’ fee of ~0.5% annually is also shared between the Advisor and her Dealer. This trailer is paid as long as the fund is held by the client. In addition to the high fess associated with these funds, something that makes DSC funds particularly unappealing – at least from the client perspective – is that these funds cannot be sold for several years without punitive penalties. These penalties usually begin at 7% of the total investment in year one, gradually declining to zero after seven years.
Front End Sales Charge (FE) – This class of mutual fund provides the Advisor and the client much more flexibility than DSC funds. At the point of sale, Advisors have the option of charging the clients a fee of anywhere between 0 and 5% of the total value of the transaction. This fee can be negotiated between you and your Advisor. Many Advisors choose to charge nothing when recommending front-end fund. In exchange for receiving nothing up front, advisors receive trailer fees which are higher than on DSC funds - usually around ~1% per annum. Unlike the DSC option, FE load funds can be sold at any time and without penalty (short term trading fees are standard, usually 2% if the fund is sold within 90 days of purchase). It’s also important to understand that if your Advisor recommends a FE load fund and charges a full 5% fee the total amount invested is reduced by this amount – a $10,000.00 deposit, therefore, will only see $9500.00 invested. In the case of a DSC fund, on the other hand, the full $10,000.00 would be invested.
F-Class – These are funds where there is neither a sales charge or an ongoing trailer fee. F-class mutual funds have the Advisor compensation stripped out of the funds total Management Expense Ratio (MER). This means, for example, instead of a MER of 2.3%, the MER on a F-class mutual fund would be 1.3%. F-class funds are used exclusively by fee only or fee based Advisors who were previously discussed.
Financial Advisors, Investment Advisors & Stock Brokers
Financial Advisors who are licensed by the Investment Industry Regulatory Organization of Canada (IIROC), might use any number of different titles other than Financial Advisor, such as Investment Advisor, Wealth Manager, Stock Broker - the list goes on. One commonality they share is that they can be compensated in several different ways, such as:
- Trading commissions charged when a client buys or sells a stock or ETF;
- Fees (embedded) in Initial Public Offerings and New Issues;
- Mutual Fund fees as described above, or;
- On a fee based on the percentage of assets under administration - similar to a Portfolio Manager.
In terms of trading commissions, this group of Advisors has a lot of lee-way when it comes to deciding what they’re going to charge their clients. Some charge a fixed dollar amount for buy and sell transactions – perhaps $125.00 per trade. Other times they might charge a percentage of the total value of the transaction, which might top out at 2 - 2.5% of the total dollar value of the transaction. This percentage amount can, however, be much higher. Advisor trading commissions are always negotiable – there is generally a floor, below which the Broker will not be paid by his or her Dealer.
These Advisors can also charge a fee based on the amount of assets they manage – identical in the way Portfolio Managers charge fees. A flat fee of perhaps 1.25% per year will cover the cost of a set number of ‘free’ trades per year. It would be reasonable to expect around 20 – 25 trades for the first $250,000.00, increasing as the amount of assets under administration increase.
Fee Only Financial Planners
Sometimes known as Fee For Service Planners, this group of Advisors don’t provide investment advice, nor are they registered to do so. Instead, Fee Only Planners provide advice focusing on financial and retirement planning, cash flow planning, budgeting, etc. Fee Only Planners charge fees on either an hourly basis, a project basis, or on retainer. Generally speaking you should expect to pay anywhere between $1500 and $2500 for a basic financial/retirement plan – however more complex plans can cost well over $10,000. Fee Only Planners bill clients directly in the same way a lawyer or accountant would - and unlike all other Advisors - you can pay them with a cheque.
The Future of Advisor Compensation
Amongst professional Financial Advisors and Portfolio Managers - indeed, the type of Advisor profiled here on SeekAdvisor- there is a strong and growing industry trend towards full and complete fee disclosure. Consumers should expect nothing less. Although not yet common practice, Advisors such as Markus Muhs of Muhs Wealth Partners of Canaccord Genuity are trailblazing into the future - providing a robust and very clear scenario based description of their various fee options.
At the other end of the spectrum are a class of Financial Advisors who offer their clients little in the way of value and more closely resemble salespeople, rather than Advisors. These Financial Advisors view fee disclosure as a threat to their livelihoods which can result in uncomfortable client conversations followed by client departures. In an act of self preservation there has been instances where Mutual Fund Advisors have engaged in regulatory arbitrage - dropping their mutual fund license while maintaining their insurance license where regulatory rules don't require fees to be disclosed to clients.
From a client perspective, full and clear disclosure of Advisor fees in dollar terms should be expected and not provided on an exception basis. In spite of recent rule changes under CRM2, regulators have set the bar low - quite literally going only 'halfway' by providing the masses (mutual fund investors) with watered down disclosure rules.
Danny MacKay is the founder of SeekAdvisor, a former Bay Street Executive and Industry Insider turned Investor Advocate. If you have any questions or comments about this article please feel free to reach out - firstname.lastname@example.org