The Canadian Securities Administrators (CSA) introduced new requirements in 2013 to ensure that investors receive specific information about investment costs and how their investments have performed. These requirements were phased in over a 3-year transition period from July 2014 to July 2016. Known as phase 2 of the Client Relationship Model, or CRM2, these rules apply to all dealers and advisors licensed to trade.
Three key affected areas include:
- More information about transactions.
- More information about commissions, like what you pay to a broker or agent for their services (often called a “sales commission”). For example, you may pay a fee to someone who buys or sell stocks or mutual funds for you.
- More information about the performance of your investments.
So, how are we doing?
Credo Consulting is an independent research consulting company. They interviewed 5,000 investors, and asked the following question:
“As a result of the implementation of new standards for reporting to investors, are investors more knowledgeable with respect to the costs associated with their investing?”
Before the introduction of CRM2’s new reporting requirements, 67% of investors indicated that they felt their advisor didn't charge them a fee for their services – that they effectively worked for free. Now, after the implementation of the new standards, people are seeing the new form of reporting that is required to disclose the cost of investment products.
There are now only 62% who think investment advice is free. Despite all the CSA’s work to improve disclosure on the cost of investment advice, Credo’s findings represent only a 5% improvement. Only 38% of retail investors are aware that they are paying for the advice they receive.
Therefore, as much as the statistics show that the implementation of CRM2 has likely had a positive effect, research also reveals that there is still room for improvement.
So, how do advisors actually get paid?
Commission-based accounts: clients pay their advisers through commissions associated with investments. These commissions are generally a percentage of the investment bought or sold. Commissions may be paid up front or may be buried in the cost of owning the investments. This type of account is becoming less common.
Fee-based accounts: clients pay fees based on a fixed percentage of the value of their portfolio. This type of account is becoming more popular. Fees are often paid on a monthly or quarterly basis.
But that’s not the end of the story if you hold mutual funds in a fee-based or commission-based account. Why?
Mutual funds: Mutual funds have internal fees that come out of your returns called management expense ratios (MERs). These fees typically range between 1.5% to 3.5% depending on the fund. The client pays these fees in addition to either fee structure listed above.
The advisor receives a trailer fee from the mutual fund company, which means that a portion of the fee, often 0.75%-1% of the MER, is paid to the advisor. And while some client investment statements list these trailer fees, this fee does not represent the entire fee paid by the client. The client is paying the full MER for each fund (1.5-3.5%), not just the portion that goes to the advisor (the 0.75-1% that is reported on your statement).
For example, let’s say John and Sue Smith have a fee based account with their advisor, for which they pay 1.5% of $300,000 – (the value of their portfolio). In addition, they hold 4 mutual funds for about half the value of their portfolio, or $150,000. These funds carry an average MER of 2%.
What are they paying in total on an annual basis?
- $300,000 x 1.5% = $4,500
- $150,000 x 2% = $3,000
Total is $7,500, which represents 2.5% per year on a $300,000 portfolio
If John and Sue are aware and comfortable with the fees they are paying, then all is well. Regardless, John and Sue Smith should know that lower fee options may exist for their portfolio.
From my experience in dealing with clients, many are still unaware of exactly what fees are being charged in their portfolio.
This kind of fee ambiguity would not be acceptable in any other industry, so why should it be acceptable in the financial industry? Imagine going to the grocery store and just handing over your wallet to the cashier and telling them to take whatever they feel is appropriate for your groceries. Unthinkable.
So what is a reasonable fee?
It depends on a variety of factors, including portfolio size, management strategy and whether or not you are working with an advisor.
Steadyhand, a low-fee mutual fund company, has assembled a great “Fee Tree” guide to what you should reasonably expect to pay for investment fees. I think the guide is pretty accurate based on my experience. For portfolios under $500,000, if you are working with an advisor and have an actively managed portfolio, you can typically expect to pay between 2% and 2.5%.
For portfolios over $500,000, fees would are typically between 1.5% to 2% and for portfolios over $1,000,000, fees generally fall within the 1% to 1.5% range. Passive or indexed portfolio fees may be lower, particularly those offered by robo-advisers, and may be in the 0.5% to 0.75% range (including exchange-traded fund embedded fees).
For Globe & Mail subscribers, check out Rob Carrick’s fee disclosure tool. You can disclose your investment fees – if you know them! – and see how your answer compares to others.
Of course, fees are certainly not the only consideration when analyzing your investment portfolio. As with all other areas of financial planning, individual elements need to be examined, such as:
- How does your current portfolio harmonize with your financial planning goals and objectives?
- Is your portfolio generally tax efficient?
- Is your portfolio properly diversified? By sector and geographic location?
- How has your portfolio performed relative to a benchmark?
Many clients I speak with say that they are pleased because their accounts have produced “good” or “positive” returns. That’s good to hear. But keep in mind that the S&P/TSX total return index was up 21% in 2016 and 9% in 2017. The S&P 500 was up 9% in 2016 and 19% in 2017, so… I really hope your accounts were up, too.
A better assessment might be how have your accounts have performed, net of fees, relative to an appropriate benchmark? If your portfolio includes bonds, Canadian stocks, U.S. stocks, international stocks, etc., you can’t compare the entire portfolio to a single stock exchange. You need to try to come up with a reasonable personal benchmark.
A comprehensive financial and investment plan will bring together all of the moving parts of your financial life and help you build a portfolio that is fully harmonized with your retirement and life goals and objectives.
In summary, CRM2 is a great start toward fee transparency and awareness, but clearly there is more work to be done. Next, it’s not all about the fees. At the end of the day, your goal should be to have a properly diversified, tax-efficient portfolio for a reasonable fee that is compatible with your overall financial plan.