I received the following question (via Ask Nanci) from Debbie in Saskatoon:
Can you help me understand how my financial advisor gets paid? I don’t see fees on my account statements and I’m shy to ask.
Thanks for your [awesome] question, Debbie! You are certainly not the first person in Canada to look for this answer.
FIRST: Financial Advisors need to get paid. Especially if they are good, because a good FA can change your whole life—for the better. That said, every person who uses the services of a broker or advisor deserves to know what they are paying for said products and services. And unfortunately, this is not always the case in Canada.
It has been over a decade since I worked in the industry and I’m not going to comment on how any one individual, in any industry, chooses to charge for their services. But I will share with you a basic model of how most financial advisors are paid in Canada, and you can decide if that model works for you.
A very rough marker in North America is to pay 1% for advisory fees.
What does this mean to you?
An ideal situation is to pay a 1% fee on your total assets. It is not super realistic to pay 1% on cash balances (it’s not exactly high maintenance, cash…) and so the breakdown often looks something like this:
Fixed income: 0.75%
Therefore, a $500,000 portfolio of 55% equities, 40% bonds, and 5% cash would have management fees of $5,000 (or 1%, right?)
$275,000 x 1.25% = $3,427.50
$200,000 x .75% = $1,500
$25,000 x .25% = $62.50
And—this is important—the 1% you are paying for advisory, would include a foundational level of service for insurance, estate and tax planning—or at least to play nice with your Accountant and other advisors. Also, if you are using ETFs or low-fee mutual funds for diversification, you can expect to pay roughly 0.2% on those assets as well. Meaning your total fees for the year could be between 1% and 1.25%. Again, this is just an average.
Ok, you knew it was coming—math.
(the title was supposed to read “Very, Very, Very Important Financial Advisor Math”, but it wouldn’t fit on the slide… Click on the image to make in bigger!)
Stay with me on this one.
Assumptions on this slide:
- Advisor is charging 1% per year
- Advisor has to share 50% of her revenue with her employer
- Advisor can realistically see no more than 300 clients per year
And what this means is that if an advisor plans to earn $112,500/year, she cannot realistically accept any clients without a minimum balance of $75,000. And if that same advisor intends to earn $247,500/year, she cannot afford to take on a client without a minimum account balance of $165,000.
The reality of the situation, is that many of the best financial advisors in Canada have a minimum balance requirement of $250,000. Which, in turn, means that most of us simply cannot afford (yet!) the services of a top-level financial advisor.
The Mutual Fund Industry
Debbie did not share with me her account balance, but I am going to assume that she is not seeing a high level financial advisor. Why? Because their fees are transparent, and you pay them outside of your account. Why? So that you do not lose the compounding benefit of these fees year after year, and so that you have a receipt because investment advisory fees are tax deductible.
Because Debbie is not 100% clear on what her annual fees are, my best guess is that she is holding mutual funds, through either her bank or a mutual fund company (i.e. AGF, Fidelity, McKenzie). Without knowing the specifics of Debbie’s account, I can tell her (and you) that the average MER (annual management expense ratio/fee) is 2.5%. If that seems high to you, especially in comparison to the 1% charged by top financial advisors, you are right—they are high.
In fact, not only does Canada have the highest MER’s in the world, but Morningstar recently (2011) gave Canada a failing grade for it’s high fees, the highest of 16 countries. It was the only country on the list to receive an F.
What would my advice be to Debbie?
If she is shy to speak with her advisor, she can simply look at her statements and Google the names of the mutual funds she is holding. Adding “MER” after the mutual fund name, will bring her to several websites (Morningstar, Fund company, GlobeInvestor) where she can locate the MER for each of her funds. At this point she can decide if the fees she is paying are worth the services she is receiving.
And if Debbie is not happy with the fees she is paying for mutual funds or investment advice, she can click here to read my post, Just Found Out How Much You Are Paying In Mutual Fund Fees?
Whew! That was a long one—thanks for sticking with me to the end.
If you have any questions, don’t hesitate to send me a note through Ask Nanci.