Anatomy of a Financial Adviser – the real truth about fees and commissions

I was disappointed to read an article penned by a Canadian business journalist with impeccable credentials where the author in this article presented clearly biased information. In order to address bias or a temporary lack of journalism standards, I thought I would open the “books” wide open, and continue with my series of articles that divulges exactly what a financial adviser makes, how he makes it and let our readers decide if securities regulators should eliminate cheaper commissions, replace them with higher fees and force advisers to bill their clients.

I am “dual-occupied” adviser meaning that I am allowed to sell mutual funds as a financial adviser and also registered to sell GICs as a deposit broker. For mutual funds, I fall in the category as a “Dealing Representative” under the self-regulatory organization called the Mutual Fund Dealers Association (MFDA). As I work in the province of Ontario, the provincial securities regulator is the Ontario Securities Commission (OSC).

For GICs, I am also registered with the Registered Deposit Brokers Association (RDBA). The deposit brokerage role I have is considered to be an outside business activity (OBA) with respect to the dealer’s mutual fund business. Under MFDA guidelines, the two businesses must remain separate and distinct although there are guidelines under the MFDA that require the Dealer to monitor any approved “outside business activities” (OBA).

For some historical context about the “how and why” of front-loads, deferred sales charges and low-loads please refer to my fees and commissions guide.

I can describe myself as a zero commission adviser where for the last 15 years or so, I would waive my commissions so that I would charge a front-end load of 0% commission for the purchase of a new mutual fund. This does not mean however, that I am not earning any compensation!

I would earn anywhere from 0% to a maximum of 1.25% annual compensation depending on the type of mutual fund. For instance a stock based mutual fund would pay me 1.00% to 1.25% annually. The 1.25% ones are relatively rare and these are mostly mutual funds offered by the Canadian banks. A more typical remuneration for a regular stock based mutual fund is 1.00%. In general, a money market fund pays me nothing, a bond fund pays me 0.25%, and a balanced mutual fund pays about 0.50%.

An analysis of my book of clients indicates average remuneration of approximately 0.80% annually for mutual funds as I tend to lean to more equities (stocks) and use GICs as my bond (fixed income) replacement. I haven’t quite figured out my overall total asset-under-management commissions (under the current commission system) but it could be as low as 0.30% per year.

Where does this compensation come from and who pays it?

The remuneration is paid by the fund company to the adviser’s mutual fund dealer (the adviser’s head office) and then to the adviser’s branch. The adviser only keeps a portion of this remuneration. This percentage is called a “payout”. The Dealer deducts my expenses from my remuneration: licensing, postage, insurance software, etc. and the branch pays me a percentage of what is left. For GIC’s, I get paid by the bank.

How does the investor pay the adviser’s compensation (for mutual funds)?

The adviser’s compensation is built into the price of the mutual fund. The built-in compensation is disclosed and new changes in regulation means there will be even more disclosure in the future.

Despite all the increased disclosure, Canadian securities regulators are mulling over proposals to eliminate commissions entirely and imitate the U.K and Australia experience. If this happens, then all investors who wish to deal with an adviser would be forced to pay a discrete fee. The regulators feel that having separate fees and bills would ensure that investors would be fully aware of the cost of investing and the cost of their adviser. Although the regulators are aware that this will drive up the costs of investing they feel that the additional disclosure is worth the human costs and monetary costs (hundreds of millions?) to convert to a fee-based system.

Right now there are two different types of separate adviser compensation models:

  1. Commissions
  2. Fees

The Canadian Securities Administration (Canada’s possible, soon-to-be, national securities regulator) is proposing to ban all commissions completely but has not proposed a replacement. The industry is presuming that the only model remaining (fees) would be the favoured model.

[Editor’s note: With the choice of only the one option, the choice becomes self-evident.]

I have used both types of remuneration models –essentially the difference between the two is whether the adviser compensation is built-in (embedded and disclosed) into the price of the mutual fund or is charged separately to the investor as a bill/fee.

On paper, whether the fee is built in or not should not make any difference to the total cost to the investor. It would be the same as buying a wrench at Canadian Tire and having the tax built into the price of the wrench or the tax being charged separately at the check-out. The total price of the wrench – remains the same.

In reality, life is not so simple. Both models (commission vs. fees) will not be the same at the check-out. The problem with a regulator imposed fee structure is that you will be charged a fee on the whole account so that the low 0.25% and 0.50% commissions you may be paying now will be replaced by 1.00% (or higher) fees. In effect, you are replacing low commissions with much higher fees.

Additionally, many readers would be surprised to find out that if investors are forced to pay fees (if the proposed changes are approved) instead of paying commissions, your account must be of a minimum size. It depends on the firm but account minimums typically start at $100,000, $250,000 or higher just to have the privilege of paying for your adviser’s advice separately. If you don’t meet the minimum account size requirement then you won’t have access to an adviser and you will be left by yourself to figure out your own investments. Certainly these could be recipes for disaster especially for the young novice investor and especially for a senior investor who would need the guidance and wisdom of a financial adviser.

Business journalists and some investor advocates seem surprised that some advisers (myself included) do not want a substantial pay raise for doing the same amount of work and that dramatically increasing fees is plainly not fair to all investors. The brunt of the pain will be felt by smaller investors[1] who will be faced with the highest fee increases of all. And unfortunately, we advisers have very little say in the matter.

The sense I get from some investor advocates, the no-help mutual fund companies (Steady Hand, for example) and even the U.K securities regulator is that the demise of the small investor is merely acceptable collateral damage –a casualty of war whose losses are entirely acceptable. The thought often expressed is high net worth investors will be relieved of the burden of subsidizing the small investor and that the small investor will be cut adrift and left to their own devices to find financial advice.

In my personal view, I am completely aghast by such callous attitudes. Who speaks for today’s small investor? No one it seems.

As we already have openness and transparency in a commission based account, why would you say that higher fees are somehow more open and more transparent than lower commissions?

What is transparent to me is that the small investor gets kicked in the teeth.

To show how incongruent the press is on this topic, on the GIC side of my business I get paid by the embedded compensation built into the interest rate on the GIC. The built-in (embedded) compensation is paid directly to the adviser. Investors pay no fees to buy a GIC but the adviser is paid a commission paid directly from the bank. Exactly the same system used for mutual funds.

In a theatre of the absurd, to the press embedded and non-disclosed GIC commissions are perfectly OK, but open and disclosed commissions for mutual funds are not.

[Editor’s note: in the interest of full disclosure, I earn one time commissions for each GIC purchase of 0.20% to 0.25% per year of maturity on GIC business. Under the current commission structures, there are no ongoing management fees for GIC holdings; however there are no promises that under the new proposed fee model, those same GICs or other investments will remain fee exempt permanently.]

Bottom line, what is considered to be fair and equitable compensation to someone for managing one’s life savings?

In today’s marketplace, investors should expect to pay about 1% annually for advice. Higher net worth clients might pay less and under the newly proposed fee-based system, smaller investors (if they are allowed to even have an adviser) might expect to pay more – unfortunately – much more.

The solution to this adviser’s dilemma is surprisingly simple. We know that all commissions are completely disclosed and so are fees. Regulator concerns seem to be centered on some obscure fund companies paying much higher remuneration than average, perhaps as much as 0.75% higher. The existence of these very few marginal players appears to be the primary motivation to ban commissions for the entire industry. No one has apparently thought of an amazingly simple solution to address this issue:

Regulate adviser compensation or regulate the fund companies.

Instead of banning all commissions, why not regulate them instead? Cap them if necessary. Certainly, regulators at one time had no trouble in regulating commissions for stock brokers. Why not do the same for the mutual fund industry? Certainly it is within the mandate of a securities regulator to regulate mutual fund commissions.

In my view, if commissions are eliminated we will be left with the Wild West of higher fee structures. Fees will not be regulated and anything goes. The playing field will no longer be level. For the average investor, the human and monetary costs will be high – far too high.


[1] What is a small investor? It depends on who you are talking too. One describes a small investor as having less than several million dollars! Unfortunately, I don’t rub elbows with Warren Buffet or Bill Gates and yes for them, several millions of dollars is loose change that has fallen between the seat cushions! Since there is no definition per se, I will have to make one. If you have less than $100,000 in securities then you are a small investor.

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