A thing is too expensive if the value you receive is less than the cost of acquisition. The numbers don’t matter, only the comparison matters. To get value, you must have cost. That is true for anyone buying anything.
For mutual funds, the amount you pay is the MER (Management Expense Ratio.) The percentage of the assets annually lost to others in the system. For sake of discussion it is around 2.21%. Some specialized funds are much more and some others are less.
Before deciding on if the price is fair, you must know what you get for it? There are several layers and more built-in service than you know.
Layer 1. An IFIC study found that of the 2.21% about 0.19% goes to the government as tax. That leaves 2.02% for the others in the advice and service channel.
Layer 2. After the government, asset managers get a piece. Your adviser is not your asset manager. Do not make the mistake of confusing the two roles. Asset managers do research and then buy, sell or decide to keep particular securities. They provide custodial services and reporting too. Advisers connect them to you.
If we use the American Total Expense Ratio (TER) as a reasonable estimate of the total of asset manager’s fees, transaction expenses, regulatory costs, tax reporting and other compliance costs, then about .9% goes there. I don’t have the precise Canadian equivalent amounts but the 0.9% number is not unreasonable. Most funds have actual asset management fees of between 0.50% and 0.75% plus cash costs, so the 0.90% total is in the realm.
That leaves about 1.1% for advisory fees. The person with whom you interface. That 1.1% is similar to fees charged in the US but paid as embedded trailer commissions in Canada.
Layer 3. In Canada, each adviser has an upstream dealer. They provide regulatory oversight of the individual advisers and provide other technical support, marketing, websites, access to information and more. They can get anywhere from about 30% to as little as 10% of the remaining 1.1%
Layer 4. If we use 15% as their share, as it would be for a mature advisory practice, then your adviser will receive something a bit under 0.94% of assets for their compensation. $935 on a portfolio of $100,000.
From that fee they will pay for the space where you visit with them, the telephone on which you talk and the support staff who do the voluminous paperwork. Other overhead matters a bit too. Subscriptions to electronic information services, programs to design financial plans, professional development courses and the like are common.
What do you, as the investor, get for this?
You cannot reasonably expect these services for $935. Especially the first year. On an ongoing basis and with comprehensive service, five times that would not be out of the ordinary for a fair return to the adviser. That is why two of the Canadian banks are writing letters to clients about why accounts under $100,000 are not viable for them.
There is nothing inherently wrong with unbundling the fees. The good advisers would likely prefer that. But unbundling has unintended consequences.
In the UK, unbundled fees are now the standard. Deloittes LLP did a survey of more than 2,000 investors there and found that the change to disclosure caused many people to opt out of receiving advice. Further, Deloitte predicts that about 11% of them will be shut out of receiving any advice because the fees are too little for the advisers to deal with these clients.
For small accounts with no access, the people have no organized way to learn planning and investing fundamentals. They may never catch up.
The ones who don’t want to pay the fees will find that no advice will have a bigger cost than will “expensive” advice. How many times will they sell from fear, buy on a tip, or buy the bass boat before their holdings diminish by far more than reasonable fees would have cost?
I choose to blame the advisers for this and not the clients.
They have never elucidated their value proposition and perhaps cannot. For those with deficiencies in their value proposition, the disclosure mandate can make them better. They will be forced to fill the holes or they will lose part of their income if not their clients. It is time to do a formal review of your value proposition and publish it. It is the adult thing to do.
Clients cannot get something for nothing, and once compensation is transparent advisers will not get too much for too little either.
It is a fundamental rule of life that over the long run there is no practical way to get something for nothing. Whether you are the investor or the adviser or the distributor or the manager, it is a fool’s game to try.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. firstname.lastname@example.org