How am I paying for financial advice?

The financial services industry throughout its history has often been a bit cloudy as it relates to how individual investors pay for the financial advice they are receiving from advisors. I find that this is still especially the case here in Canada. There have been recent regulatory changes which now require financial dealer firms to report to their clients in dollar amounts how much of what they are paying is going towards their advisors compensation but for my mind I feel that these new regulations have only gone part of the way and more transparency is still required.

For example, the reporting that is being given to investors doesn't yet include all of the management costs that an investor might be paying as it still does not report mutual fund management costs (also known as MERs). Reporting of these fees is expected in the next stage of regulatory reporting coming in the next few years.

Additionally, what I also find confusing about this reporting is that it can appear to present that the dollar figure being reported is being paid to their financial advisor completely, which is simply not the case. Components of the reported fee will be paid to the firm the accounts are with, to cover account costs such as transactions, will be used to pay for statements and other reporting, will pay for support staff such as investment associates and so on.

As I said, this can all be very confusing and so I thought I would shed some light on just how it is that Canadians pay for their financial advice, in particular by focusing on the three main ways which financial advice is paid for today.

Transactional Commissions

Although not as popular as it used to be, there are still many advisors who charge commissions based on the trades that they complete for investors. With this approach investors will pay their advisors firms a percentage of the amount being traded whenever they buy or sell an investment security. Typically these commission charges can go as high as 2% although there are some products which can have higher commissions associated to them.

As a reference point, for every $10,000 being traded you can expect a commission of $200 to be charged. Advisors don't have to charge a percentage per transaction, some dealers/advisors will just charge a flat trading fee. An advisor may charge $300 per trade as an example regardless of the size of the transaction. Discount trading models where investors perform their own trades typically follow this model as well and will charge generally in the range of $10 per trade. This form of compensation is historically how advisors got paid and typically represents more of an investment focused relationship between the advisor and their client.

Fee for Service Advice

Although not widely adopted here in Canada, some financial planners will charge what's called a fee for service for their planning work. Under this model, the advisor would charge their client a rate generally based on the time they spend working on their clients planning. Similar to a lawyer, the financial planner/advisor would charge the client for billable hours. Some advisors may set a flat rate for their services where they will charge up to $10,000 for a comprehensive wealth plan and then charge a smaller amount annually to update and monitor the plan.

I can see this method becoming more popular in time, or perhaps a variation of it where investors would pay their advisor an annual retainer for their services. Advisors that typically fall under this model are more focused on financial planning than they are on investing. As I said, this method of payment for advice is not widely adopted at this point, in fact I am unaware of any major investment firm that currently allows this method of compensation. Perhaps in time.

Percentage of Assets under Management

Also known as fee based advice, this method of payment for advice has quickly become the most popular method of paying for advice in Canada. Under this model, investors will pay their advisors firm a fee based on a certain percentage of the assets they have managed at that firm. The percentage itself can vary to a wide degree, typically depending on the level of assets the investor has and also it should vary based on the services that the advisor offers. For families with investments of $250,000 you can expect this fee to range from 2-3% per year. With asset levels closer to $1,000,000 the fee can range typically from 1-2% per year.

This is also how investors who have money invested in mutual funds or exchange traded funds pay for the management of their investments, although as I mentioned in my first paragraph, these investors often aren't aware that they are paying fees at all for these products. Mutual funds which have an embedded advisors compensation included will often charge investors fees in the range of 2-3% per year. There are a number of different classes of mutual funds which have different fee structures so it's important to know which one you own and how the costs work.

As an example, in our business we use what is called f-class mutual funds which separate out advisor compensation from what the mutual fund charges. We used this class of funds because it allows us to make our clients costs more transparent so they can see them, know that we are providing value for what they are paying and it also makes our management costs tax deductible in their non-registered accounts. Exchange traded funds often have lower fees than mutual funds as they are not actively managed and simply track an index. These fees often range from .15% to.75% per year, depending on the fund itself.

For bank branch investors, it's important to note that mutual fund fees is often the biggest component to the total amount of fees you are paying overall, and as of the time I am writing this, you do not typically receive transparent reports showing that fee.

Although I am biased, as fee based advice is our preferred method of charging for our services, I still believe that as it stands today, this is the fairest compensation method in Canada for financial advice. Unlike other methods, fee based advice completely aligns client goals with their advisors as the advisors incentive will be to preserve and grow their clients assets, unlike in a transactional model where the advisors firm will be compensated as long as trades are being made.

Typically for fee based advice, advisors should be offering a plethora of other services on top of investment advice, including financial planning, estate and tax planning, insurance and so on. There are many different ways that you can pay for financial advice in Canada as you can see. What is most important is that you understand what it is you are paying for advice, understand any 'hidden' fees that may be being charged such as mutual fund MERs, and ensure that you are receiving value for what you are paying.

Of course, if you have any questions on this or if you would like to better understand what you are currently paying for advice then give me a call.

- Grant White, CIM, CFP

Grant White is an award-winning Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.