Mutual funds are not free: Questions and Answers
Although investors and consumers inherently understand that the products and services they consume are generally not free (including mutual funds, GICs, and other investment products), they may not know all of the specific details regarding an adviser’s remuneration and how it works.
With the advent of the internet, I have been disclosing all aspects of my remuneration since the late 1990s. Starting in 2017, all mutual fund investors will be given a cost-reporting statement which details exactly – in dollars and cents – all the costs associated with the investment funds specific to their accounts.
In reviewing these new reports, some investors may be asking themselves the following questions:
Question: Do financial advisers earn a fee or commission?
Answer: Yes, they do and how advisers are paid depends on the type of investment. A GIC for instance, has adviser remuneration built into the price of the product. GIC commissions are generally not disclosed although this may change in the future. With a mutual fund, you can choose (at least for now) to either pay a separate fee to your adviser or have the commission built into the price of the product. Both fees and commissions are disclosed for mutual funds.
Question: What is the difference between a fee and a commission?
Answer: Commissions are usually transaction-oriented. For example, you pay a commission when you sell or buy stocks. Fees can be charged for the holding/servicing/management of investment assets regardless of transaction activity, and they are usually expressed as an annual percentage of the assets under management (AUM). Oddly, mutual fund trailers, which should be described as embedded non-transactional AUM fees, have been referred to as commissions and at other times, as fees.
Question: How does an AUM (Assets Under Management) adviser fee work and where does my money go?
Answer: If an investor has $100,000 in mutual funds, they might pay 1% or, in dollar terms, $1,000 per year to their adviser’s firm for the management of their assets. The adviser receives only a portion of that fee, and they typically earn half or a bit less than that (gross) before adviser expenses (e.g. office lease and supplies).
Question: I don’t quite understand. Am I paying an extra 1% on top of what I am already paying?
Answer: No. It is important to distinguish between a separate billable fee and an embedded commission that’s already built into the price of the product. Think of a fee or commission in terms of the HST sales tax – a product can either have the sales tax built into the price or it can be charged separately at checkout. The total price of the product at checkout is exactly the same whether it is already built into the price or charged separately. In both cases, the exact tax amount is detailed on the receipt.
Question: Whether the fee is embedded or not, it is a “wash”. Why bother changing the system?
Answer:Interesting question and one that has been debated vigorously in this blog.
Question: I have never heard of being billed for mutual funds. I’ve never had to pay this before – what gives?
Answer: Paying a professional to manage your wealth has been around for many decades, if not centuries. The implementation of “bills” or fees (to replace commissions) on mutual funds in Canada is, however, pretty new. You can have fees built into the price of the product or have them charged separately. The fee structure that has been proposed by the regulators calls for un-embedding the fees that would otherwise be built into the price of the product. Investors should be aware that the built-in fees that they are currently paying under the traditional system have always been disclosed in the mutual fund prospectus and now, in the new Fund Facts document.
Question: I don’t like to be billed separate fees! Can’t I use the same system I’ve been using for years?
Answer: For now, you can continue to do so but the decision is outside of the scope or mandate of financial advisers, and the regulators will be making that decision soon - possibly late 2016 or early 2017.
Question: You mentioned that the new investor cost reports that will be released in 2017 will contain dollar amounts only. When I see just a dollar cost figure by itself, the first thing I think of is, “In relation to what?” Bottom line, how much should I be paying percentage-wise? What is considered fair and equitable?
Answer: The omission of percentages in the new upcoming cost report was certainly a surprise. The investment costs and performance for mutual funds are traditionally quoted in both dollars and in percentages so that investors can have a basis for comparison. In the absence of percentages in the new report, investors should be aware that a 1% annual fee (based on the market value of your account) for managing your wealth is generally considered to be fair and equitable remuneration. However, this percentage can vary depending on the type of investment and the size of the investment account. In reality, the annual fee would be spread out and paid quarterly or monthly throughout the year. I encourage all investors to review their cost report with their adviser so they can gain a clear understanding of all of the fees or commissions they are currently paying.
Question: Fees are tax-deductible but commissions are not. Does this mean that fees are automatically better?
Answer: Absolutely not! There has been quite a bit of confusion regarding the tax-deductibility of fees. Although I am not a tax professional, my understanding is that fees are only tax-deductible for regular open accounts, not for RRSPs, RRIFs, TFSAs, or other registered plans. Further, it is important to understand that a tax-deductible fee is equivalent to a non-tax-deductible commission for a regular open account. Tax wise, there is no advantage either way if the fee amount is the same as the commission amount.
In all cases though, it is best to consult with your own tax professional.
Question: What do advisers feel is the best system – fees or commissions?
Answer: That is a tough one to answer and is subject to some discussion as it depends on the investor’s personal situation.
For me, it boils down to selecting the investments that are in line with the best interests of the investor. Fees and fee-based accounts tend to work better for wealthy investors as fees are proportionate to account size.
For the majority of us that are not yet considered to be high net-worth investors, my view is that good old fashioned commissions are still in our best interests. They are transparent and disclosed, and can be significantly cheaper than fees. In my opinion, therefore, a low commission is better than a high fee.
I have always believed that it is better to have more choices so choose the option that best fits your unique situation.
If you have additional questions about the new cost reports or fees/commissions in general, please contact me at email@example.com.