There are two basic ways in which you compensate your investment advisor: either you pay a transaction fee each time you make a change or you pay an annual fee for service. Thing is, these two compensation methods each have several variations, combinations and permutations, and degrees of transparency. It’s important to understand and align your chosen method with your investing goals.
(A) Transaction Fees:
Commissions: These are fees charged when you buy and sell stocks, bonds, and Exchange Traded Funds. Commissions vary, but are generally based on a percentage of the total dollar value of the trade (market price x number of shares) or a flat dollar amount.
Mutual Fund Sales charges or Front-end Load charges: If you pay a fee when you buy the fund, it’s called an initial sales charge (you’ll see the acronym ISC on your statement) or front-end load fee. Fees paid at the time of purchase also vary widely and, importantly, it is typically the advisor’s choice whether to charge this fee and what percentage to charge.
Mutual Fund Back-end Load or Deferred Sales Charges: This is a transaction fee you pay when you sell units of your mutual fund (look for the acronym DSC on your statement). The amount you’ll pay typically varies according to a schedule whereby you pay a lower transaction fee the longer you’ve held the fund. Again, importantly, it is typically the advisor’s choice whether to choose that version of your mutual fund that charges a transaction fee to sell.
(B) Annual Fee for Service
Management fees: These are annual fees your advisor charges based on a percentage of your portfolio’s market value. This annual fee varies and usually covers all of the costs of managing your portfolio. Since you do not pay a transaction fee, decisions about buying and selling can be based on merit rather than transaction cost.
Fee for service: This is a model in which you pay an hourly fee or a flat fee for a service such as an independent evaluation of your portfolio, a financial plan, or an estate plan. This method is not generally used for ongoing advice, but rather for periodic and specific services.
Mutual Fund Management Expense Ratio (MER): Each mutual fund has operating expenses including legal, accounting, and fund management expenses. The MER is the total of the expenses expressed as a percentage of the fund’s value. The higher the MER, the more you indirectly pay for management and administration. MERs may be high because the fund manager actively researches, trades and manages the fund and there are high operating costs, such as legal fees. The higher the MER, the more the fund will have to earn in order for you to make money.
Mutual Fund Trailer Fees: The advisor who researched and recommended your mutual fund often receives an annual fee from the mutual fund company, which it pays out of the management fee you pay them for as long as you own that fund. This annual fee in the form of a trailer is to compensate the advisor for ongoing services including annual reviews, portfolio rebalancing, and financial planning. Thing is, most people don’t realize or remember that they are inherently paying this annual trailer fee and therefore don’t realize or remember that are owed a service for that fee.
All this is to say that there are several variations on the two basic methods of compensating your advisor: Transaction Fees and Annual Fees. Some variations are more transparent than others, so do your homework, ask questions, and figure out which method is best for you right now.
Heather Holden, PhD, CIM
Wealth Advisor, ScotiaMcLeod