Don’t buy DSC mutual funds
Recently I wrote about one investor who was tired of paying higher management fees on her DSC mutual funds. When she wanted to pull her money out, she was faced with a back end load also known as a deferred sales charge (DSC). She wanted to know if it made sense to pay the DSC?
Do it yourself investing?
In the example from my last article, Ellen wanted to move from advisor recommended mutual funds to a do-it-yourself version through the TD e-series.
Related article: Financial advisor or do it yourself
The challenge for many investors is they won’t, can’t or shouldn’t do it themselves. I’ve told many investors that we live in a time where investors have the tools and information to invest their own money if they choose but they have to have the time, passion, knowledge and desire to do it themselves. Not everyone has these qualities, which means that many investors will have to get help from financial advisors.
Should financial advisors get paid?
The economic reality is that good financial advisors deserve to get paid. It’s similar to the fact that I could build my own deck. There’s information and tools out there for me to do this but I have to want to do it and I have to feel confident that I can do it. If I hire someone to do it for me, I have to expect that I will pay more than trying to do it myself.
Related article: How to financial advisors get paid?
Moving to another advisor?
I recently talked to another investor who was not happy with one of his investments and advisors. Let’s meet Carl. Carl was not like Ellen in that he was not interested in investing himself. The idea of investing his own money is interesting but he does not have the confidence that he can invest properly. As a result, Carl wants to consolidate his money by moving money from one advisor to another? DSC mutual funds can still create significant problems.
Carl has $18,994 in the Primerica Aggressive Growth Fund with his Primerica agent. He is not happy with this advisor and wants to move this money to his other financial advisor that has money invested in the Dynamic Power Cdn Growth.
The problem is to get out of the Primerica mutual fund, he would have to pay $797.54 which is the equivalent of a 4.21% penalty.
After reading my last article on Ellen, Carl was wondering if it made sense to pay $797.54 to move from the Primerica Fund which has a MER of 2.72% while the Dynamic Fund MER was lower at 2.42%.
Related article: ManagementExpense Ratios do matter
Should he pay the DSC?
On an $18,994 investment, the annual fee savings would only be $56.83 (2.72% minus 2.42% times $18,994). The math suggests that it would take 14 years to make back the $797.54 back end load.
In my humble opinion, that’s not enough of a fee savings to justify the one time cost. It’s just too big of a penalty. In other words, it’s too long to breakeven.
Not an apples-to-apples comparison
The Primerica fund is a global equity, while the Dynamic fund is a Canadian Equity. Although I do think the Primerica MER is too high, global funds will typically have a higher MER than Canadian Equity funds.
Carl can switch to a different fund at Primerica but he is not happy with the advisor. One of the challenges that Carl faces is that the Primerica Advisor is a proprietary advisor that only sells Primerica Funds. He can’t even move the money to his other advisor for this reason.
Any way you look at it, DSC mutual funds are not great! The investment industry has evolved and investors should avoid DSC mutual funds whenever possible. There are many advisors willing to invest on a no-load basis. The bottom line is don’t buy DSC mutual funds if you don’t have to!
My involvement with mutual funds, is typical of many investors,
not knowing how to invest, I went with my financial institution.
What I got was not an adviser, but a Funds Salesman, although he
claimed to be a financial adviser. I initially though that he was working in my best interest, however this was not the case.
My mistake was not asking to see his credentials. Since dealing with this individual, I have learned that he was fired, no reason given and is now working in another field. The old saying: buyer beware, is now my motto.
“Should financial advisors get paid?
The economic reality is that good financial advisors deserve to get paid. It’s similar to the fact that I could build my own deck. There’s information and tools out there for me to do this but I have to want to do it and I have to feel confident that I can do it. If I hire someone to do it for me, I have to expect that I will pay more than trying to do it myself.”
A bit of a incomplete comparison.
If a professional builds your deck and it fails, you could most likely sue said builder and he/she would most likely be held to some kind of liability. As well, you could most likely collect some kind of insurance on both property and personal damage.
With a financial advisor, however, they have zero liability. If the markets fail and you lose all your money…well, that’s all there is to that story. Too bad, so sad.
Thanks for the comment.
The difference is that advisor has no control over the markets. That is a different problem in itself but it’s still an important difference.
Sorry but we have to agree to disagree. NO ONE, not even good advisors or money managers can have the foresight to see and predict the future.
So what you are saying is that NOT ONE financial advisor in the entire industry has the ability to take a look around, view the economic landscape (global and local), and all other influential trappings, and make intelligent decisions on where to allocate capital?
How did Soros make almost a billion dollars from the British Pound?
How did Kyle Bass and Peter Schiff make fortunes from the sub-prime crisis?
How did Buffett make billions from currency trades?
How did Taleb make millions from both the 1987 crash and the 2008 crash?
And those are just the famous ones.
It was all foresight and prediction of the future.
You have to place your bet BEFORE the event occurs.
I do agree, a run of the mill mutual fund sales person will never be able to emulate a good manager, and a run of the mill mutual fund will never be able to emulate a good portfolio.
DSC funds were once lauded by the press in the 1980’s as they allowed investors to elude the lofty 6% or higher front-end commissions at the time.
DSC funds are rarely lauded now as they have somehow been pegged by the press as inherently evil. I don’t agree with that view although I think they have outlived their usefulness now that commissions are pretty much at 0%.
Since 90%+ of FE purchases are 0%, really what has happened is that DSC funds reason d’être is no longer relevant as advisers are steering clients to 0% commission models for the 1% AUM fee.
Oddly, despite DSC funds falling popularity (for the reasons given), it is interesting to note that DSC funds may dissuade a client to sell when they shouldn’t. I am developing a theory that based on behavioral economics, given a scenario like the Great Panic of 2008 – 2009, DSC funds may have done better than their FE counterparts which may have sold off in a panic during the crisis. I am not aware of any studies that might support that view.
However, famed behavioral economist, Dan Ariely does give us a hint about investor behavior that suggests that instant access to our money is not always a good thing:
“Whatever you do, I think it’s clear that the freedom to do whatever we want and change our minds at any point is the shortest path to bad decisions. While limits on our freedom go against our ideology, they are sometimes the best way to guarantee that we will stay on the long-term path we intend.” — Dan Ariely, author of New York Times best seller, “Predictably Irrational”.
I am no different than the average adviser as most advisers are already migrating or have already migrated to a 0% commission world. You are correct of course. Given a choice of a DSC fund or a 0% FE fund, which one would you rather have? Both funds have the same identical performance and internal costs, yet the DSC fund has the possibility of early redemption charges if you have to bail out before the fund’s maturity schedule expires in 7 years.
Given a choice, you would of course, prefer the front-end fund that can be sold at any time without penalty. Chances are you won’t even have to negotiate a 0% commission anymore. The adviser will in all likelihood will have already waived it.
However, if your adviser still charges a load, the choice is not so clear especially if you can withdraw 10% a year free from the DSC fund.
I recently went to a certified financial adviser who advised me highly to stay away from DSC funds. I understand that it does seem to put a bad vibe on DSC when thinking about the liquidity of the money in there. At the same time I believe that the money you are investing should be in there for the long run. It is being inverted because you can afford to have it inverted, ie you wont need it right way or in the near future. We can not predict the future as to what will happen to us or when we will need that invested money. Realistically if you take the money out within that 7 years that have DSC charges you lose that oh so important period of early growth that with compounding intrest will grow you money. Its like a reminder as to why you put the money there in the first place, to go to work for you. If there was nothing stopping me from taking my money out it would always be in the back of my mind. “I always have that money i can draw from if i need it”. That thought soon turns to action.
My advisor gave me a full plan. Great advice, needs focused. He spent 3 meetings with us before we were done (never mind the time he spent in between preparing these presentations and plans). I had a LIRA with $30k in it and Im only 36. The choice was either DSC the $30k and the fund company would pay the commission or I could pay for the service. Now the deal was I have to leave it with said company for 6 years but we could move it to different mandates within the same company.Also had 10% annually flexibility. We picked a company with lots of good choices so even if my objectives changed I could adjust to other good choices. Besides my time horizon was well over 20 years. I was making a selection that 6 years was irrelevant. Why is that so bad? He got paid. On a 0% commission he doesn’t take my account and I don’t blame him. He loses money! I guess I could go to the bank and buy a “no load” and get crap advice or no advice at all. How is that better? It totally has its place and it’s irresponsible to make blanket statements like DSC should never be used. Even the example was silly. If the guy wanted a Cdn equity mandate with a lower MER did Primerica not offer that? If not then the issue was not DSC but the fact he went to a service provider who didn’t have a full range of quality products. Also at 4.21% he must be switching within the first couple years of buying the fund. Why a switch already? I made my decisions based on long term planning and objectives. Perhaps the problem is not DSC structure but that he failed to investigate options and determine appropriate service provider.
There’s another issue to be discussed along with DSC fees. We all agree that advisors deserve to be paid for the work they do. Those who don’t charge sales commissions generally get their money from an annual assets under management fee charged directly to the customer.
A typical model I was shown recently is for a 1.5% annual fee based on the value of my account. This means that if I need my money in 3 years time, I will have paid out more money on these account management fees than I would have paid on the trailing DSC charge (4% after 3 years).
Why are we trying to eliminate one cost, without looking at the total costs of an investment option?
One thing this blog is missing with the example of Carl is that a mutual fund Approved Person (AP) can elect to do a DSC rebate. So, in this example, if Carl met with an AP he wanted to work with, the monies could be transferred to the institution (using Dynamic funds if that is the desire), DSC commission paid to the AP could be rebated so that Carl ultimately doesn’t suffer the $800 penalty with his investment. Granted, there’s a new DSC schedule started, but if this is a long term investment, it shouldn’t matter too much.
There’s nothing wrong with DSC charges, but people need to be informed and they need to be used appropriately. For a disciplined investor, saving for the long term (say retirement savings when retirement is a number of years away, and RESP for young child / children, RDSP, etc.
Typically, DSC commission is 5%, then 0.5% per year trailer, switching to 1% trailer after DSC schedule I’s done. So, for a 6 year DSC schedule, that’s 8% (simplifying). A front end with 0% sales charge, or no load, it’s a 1% trail so over those same 6 years, it would be 6% of commission. That isn’t a massive difference that should sway an AP.
Finally, a mutual fund AP can be held liable for errors or omissions. Client complaints happen regularly and there are penalties. That is part of the reason Errors and Omissions Insurance is required on their part.
It’s more complicated than whether DSC is good, bad, or indifferent. It is a question of what is appropriate in a given situation that the AP and the client agree upon.
DSC funds get a bad rap, but they do have their purposes. (Unfortunately they are mostly used for the purpose of making the advisor a hefty front loaded commission while still able to promise the client that there are no fees).
RRSPs and RESPs would be excellent examples. Money that is going to be parked for the long haul, that has complicated or costly tax consequences for withdrawal, DSC funds can do the trick with no up front commissions. Mutual funds in general are pretty bad MER wise, but if you are a small investor making small monthly investments, the DSC route on long term funds can at least get you some respectable advice (depending on the advisor).
Anything that you would want available on relatively short notice, DSCs are horrific. You either pay the swap fee, or DSC fee if you want to sell or change the investment; this can happen for a variety of reasons ranging from just plain needing the money back or that you no longer like the fund family because their performance is crap.
I had an WFG advisor pitch my fiancee on a job, boasting about how he would make 7.25% up front on closing an account. Being in the industry, I know that is either a 7 or even 9 year DSC mutual fund. There are a lot of these MLM type financial groups out there, because the whole way the industry works lends itself perfectly to MLM type schemes.
Meanwhile I can boast an 8% target yield with exposure to capital appreciation (and of course losses) at an MER of 0.58% using ETFs. Not everyone has the time or knowledge to do sector picks like me, and they need something more watered down. A typical no load balanced fund at your local bank branch would suffice without the load headaches of front end or back end commissions.
Any account of a reasonable size, you are better off using the advice of an IIROC broker or investing it online with some fee-based advice. Many financial planners will give you a fee for service financial plan and tell you what sectors you need to buy; albeit if they are not licensed with an IIROC dealer they can’t tell you which investment to pick so you will have to do some homework on your own.
As a financial professional, my advice to clients is simple: If it’s 20 year money (ie. RRSP, RESP) DSC is fine as long as the overall MER isn’t too high. Anything outside of a registered account you should never even go near a DSC, you may want to play the market a bit, take money out or find their fee, dividend, or tax structure is punitive, maybe their returns are just junk.
Stick with a huge fund company like Fidelity or Templeton if you go DSC; because at least they have enough mandates that a switch is practicable.
The example in the article uses Primerica as an example. Those are funds to just treat as radioactive out of the gate, it is a poor example. They are DSC funds with mutual funds held inside the fund, all with layers upon layers of MERs, the performance is dismal because before the market opens your MER is so high you are never going to make any money unless you are in a raging bull market where you dont even need advice, you could throw darts at a board of stocks and make money.
Can you elobarate the following statement? How it will take that long to recover the backend load?
“On an $18,994 investment, the annual fee savings would only be $56.83 (2.72% minus 2.42% times $18,994). The math suggests that it would take 14 years to make back the $797.54 back end load.”
The reason I am asking is Primerica advisors are saying that the funds returns over 9-10% annually. so $18,994 + 9% = $20,703, which is $1709 more so if $56.83 is their annual fee, I got $1652.17 after deducting the fees. Isn’t that still a good return?