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Investors pay fees, as they do for any professional service, but many have not given them sufficient thought.
A 2009 survey conducted by J.D. Power and Associates found that 48 per cent of investors are unaware of the fees they pay. In some ways, it's understandable because there are many kinds and they vary significantly.
If you're among the 48 per cent, you should do two things.
The first is to have a frank talk with your advisor and ask for an explanation of all commissions, posing as many questions as necessary to ensure clarity.
Then think about the best fee structure for you. There is no "one size fits all" so this step requires considerable thought.
To demonstrate the importance of thinking about fees relative to the kind of investor you are, let’s consider two variations on the popular fee-based model whose cost is based on portfolio size.
Assume you are a conservative investor with a $600,000 portfolio, making a few trades a year totalling $200,000 in market value.
At an average of two per cent, the commissions would be $4,000.
However, if you opted for a fee-based account, you pay a percentage based on the $600,000 value of your portfolio. If that rate were 1.5 per cent, your annual fee would be $9,000.
It wouldn’t matter that you only traded $200,000 worth of investments; you are overpaying by $5,000.
Now let's assume you're an active trader averaging 30 trades a year. Instead of paying 1.5 per cent a year on the total value of the portfolio, you choose a commission-based account, paying on a per-transaction basis.
Assuming all 30 trades amounted to the total value of the $600,000 portfolio and are subject to the same two per cent commission, the fees would be $12,000.
In this example, you are overpaying by $3,000.
Clearly, the investment account setup is an important aspect of your fee costs and you must consider all choices.
While some investors are suited to either fee-based or commission accounts, others are better served by different options, like a blend of the two.
You must also give thought to the percentage you pay. What might appear to be a slight difference in fees can have a significant impact on the growth of your portfolio.
You may compare one per cent to two per cent and muse, “It's only one percent,” but you should think of it as a compounded 100 per cent increase in fees.
Consider $500,000 held inside a registered account for 25 years returning seven per cent annually.
Assuming a two per cent rate of inflation and a fee of one per cent, you will be left with a four per cent return, representing a compounded gain of $832,918.17.
However, if the fee is two per cent, you are reduced to a three per cent return, or a $546,888.96 gain. The additional one per cent in fees cost you $286,029.21, or $11,441.17 per year.
It doesn't automatically follow that the fee is unjustified but the advisor should be able to clearly articulate the value derived from the additional one per cent.
Is the portfolio quite active, requiring a large number of transactions? Does the entire portfolio undergo extensive rebalancing every year? Were fees offset by the benefits of tax strategies?
Any advantages reflected in that one per cent increment are meaningless if you don't understand and appreciate them.
Fees are paid for services rendered. If you’re getting good advice and top-notch service, chances are you’re happy. If you’re not, it may be time to think about a change.
Kim Inglis is an investment advisor, CIM with Canaccord Wealth Management, a division of Canaccord Financial Ltd. Member CIPF. Find out more at www.kiminglis.ca.
The views in this column are solely those of the author.
