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If you want to work with a financial advisor, there are still ways to keep costs in check.Drazen Zigic/iStockPhoto / Getty Images
Working with a financial advisor comes at a cost, but it can be hard to measure the quality of what you are getting, and keep track of how much you are paying for it.
For people who don’t scrutinize their statements, this can mean giving up a lot of money to both high fees and poor performance.
I recently did a portfolio review for a couple who works with a financial advisor from one of the big investment management companies. As I dug into the details of their investments, my blood started to boil. Their portfolio was full of high-fee mutual funds, and their returns were well below the market’s.
One fund their financial advisor had them invested in was the Mackenzie Bluewater Canadian Growth Balanced Fund. This fund charges a 2.3-per-cent fee – called a management expense ratio (MER) – and gave investors a return of 5.84 per cent a year over the past 10 years.
By comparison, an exchange-traded fund with a similar asset allocation – the iShares Balanced ETF Portfolio (XBAL), which tracks stock and bond indexes – returned 7.95 per cent a year over the past 10 years. A $10,000 investment in the Mackenzie fund over 10 years would have grown to $17,811, but the ETF portfolio would have been worth $21,689, or $3,878 more.
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This advisor had other underperforming high-fee mutual funds in their portfolio and this is simply unacceptable.
Advisors like this should be fired by their clients. And investors, don’t fret if you fear your portfolio looks like this. There are other options.
The most cost-effective choice is to move to do-it-yourself investing using index-tracking ETFs, where you will pay fees in the range of 0.1 to 0.2 per cent. Another cost-effective method is to use a robo-advisor, a kind of managed investing, with fees in the range of 0.4 to 0.8 per cent.
These options aren’t for everyone, and some people need or want to work with a financial advisor. But there are still ways to keep those costs in check.
The first step is to understand how you pay your advisor. There are two main models. The first is commission-based, where you don’t pay the advisor directly but they receive compensation from mutual fund companies.
This is commonly through a trailing commission, a payment the advisor receives as long as you stay invested in a mutual fund. The fees are quite high – about 2 to 2.5 per cent – which lower your returns from the fund.
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The second compensation arrangement is a fee-based model. A fee-based advisor will charge you a percentage of the money they manage on your behalf. This fee is often around 1 per cent and you will see it come out of your account monthly or quarterly. You will still pay the MER on any funds that you own, but those fees will be lower than the funds that a commission-based advisor will sell you.
This fee-based model can have lower overall costs than the commission-based model. A fee-based advisor can offer you less-expensive mutual funds, called F-series funds, or fee-based funds, which don’t pay a trailing commission.
The advisor can also invest your money in index mutual funds, which have substantially lower fees than the more commonly used actively managed funds because they don’t pay trailing commissions. Some advisors can also invest in ETFs, many of which will have even lower fees than index mutual funds. A fee-based advisor should put these options on the table. If they don’t, ask for them.
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Not only will you pay lower fees with index mutual funds and ETFs, but these funds do better than actively managed funds 98 per cent of the time, according to S&P Global, a capital markets company.
Before you begin working with a fee-based advisor, make it clear that you want your fees to be low. Ask them to present you with an investment proposal that uses low-cost funds, and to explain in writing what your total fee will be.
This disclosure is important because it can be hard for investors to see all of the fees they pay. Although advisors have to send you an annual report that discloses their fees, these reports usually leave out the part about the MERs on the mutual funds you own, so you’re not getting the full picture.
Starting in 2027, this disclosure will improve: The Canadian Investment Regulatory Organization will require the report to show how much you are paying on your funds, based on the MER. If you don’t want to wait that long, find the MER for each of your funds by looking online at the fund’s profile, and calculate your total annual fees yourself by multiplying the MER by the amount you have invested.
If your fees shock you, consider that a wake-up call. Push your advisor to explain why your fees are so high, or say goodbye.
Anita Bruinsma is a Toronto-based certified financial planner at Clarity Personal Finance.