Episide 4: Advisor Fees

Welcome to episode 4 of the Retire Ready Podcast, the podcast that helps Canadians prepare for all that retirement brings. I am your host Scott Sather, Founder, President, and Financial Planner at Awaken Wealth Management, and Portfolio Manager with Awaken Investments of Aligned Capital Partners in Regina, Saskatchewan. Thanks for joining me today.

This is part 3 of a 4-part series I’m doing on financial advice and what to look for in an advisor.  Today we’re going to talk about the exciting topic of advisor fees. Yes, you are paying fees, even if you don’t see them coming out of your account or receive a bill for the services- no one works for free. So we’re going to discuss what options are out there, what is a fair or reasonable fee to pay your advisor, and which of the options makes the most sense for you.

So why are we talking about advisor fees on a retirement podcast? Well, as I mentioned in episode 2 many investors look for retirement advice and planning from financial planners and advisors, so it is important to know what options they are for advisor fees so that you can come into the client advisor relationship with eyes wide open.

Now everyone measures the value they receive from a product or service differently. Everyone values their time differently. And everyone has different levels of complexities. Nonetheless, the value you receive from something or someone – however YOU measure it – should be in line with or even outweigh the cost.

With this in mind, when it comes to evaluating the cost of advice or a service, what's most important, is that you feel that you receive value from them, that those costs are transparent AND most importantly they are explained in a way that you can understand.

Unfortunately, in the world of Canadian financial services, this is where things can get murky and complicated. That’s because fees are not always transparent, and they are not always explained or communicated well. And sometimes the fees are intentionally structured or explained in a confusing way so that retirement investors don't actually know what they're paying or even how they're paying it.

You might have thought I was joking earlier when I said there are financial advisors – or financial services salespeople – who say they don’t charge fees at all. But, unfortunately, that wasn't a joke.

Now while I can't control how all of the planners and advisors in Canada structure and communicate their fees, I can do my part to educate folks so that, if and when you need to hire a financial advisor, you are equipped with the knowledge and information required to make the best decision for you and your  family.

So, that's the goal for today. To educate and try to provide you with CLEAR information about the different ways a financial advisor might structure their fees so you can make an educated and informed decision on what’s best for you and your situation.

Ok so just before we jump in, I want to emphasize three things:

First, contrary to what you might read or hear in the media, there is no perfect, one-size-fits-all fee structure. Every fee model can be a disservice to someone.

Second, all fee models contain some sort of conflicts of interest.

And lastly, once again, there is no such thing as a free service and definitely not a financial product. Even a guaranteed investment certificate or GIC has a cost- believe it or not, the bank does like to make money. The only time there may be a free service is if you are taking advantage of a pro bono advice offering through an organization like the Financial Planning Association of Canada pro bono listing.

To simplify things a bit, we can breakdown the fees to two categories of fee structures used by advisors – transactional fees and ongoing fees.

In the transactional fee category, we have commissions and the hourly or project-based fee schedule otherwise known as fee for service. By transactional I mean that you are paying a fee or commission for that product or service- it is not an ongoing continual fee. You pay a single fee in return for a single transaction or service.

As a result, you can decide for yourself how frequently you want to engage with that transactional advisor, knowing that each time you do, you will pay a fee.

Then there’s the ongoing fee category, where we have fee-based account fees or the percentage of investments being managed fee, also commonly referred to as an AUM or Assets Under Management fee, and the less likely to be seen in Canada option, of the annual retainer or subscription fee model, also referred to sometimes as “flat fees”. Like I said this is less seen right now in Canada, however, this is a growing way advisors are paid south of the border, so we will likely see it as more of an option in the future. And I refer to these as ongoing fees because YOU ARE committing to an ongoing service model. You're paying a pre-determined, ongoing fee with the intention of being a long-term user of the services being provided.

So, two categories and four different ways a financial advisor might charge for their services. And as previously noted, there is no perfect one-size-fits-all fee structure. Each one has its benefits and drawbacks. Choosing the right financial advisor and the right fee structure will depend on your unique needs, goals, and situation.

Let's break each one down by starting with the transactional fee category.

So… commissions. This can cover a lot of the Canadian financial advice landscape today. Commissions can be visible, meaning you see the cost upfront or in your transaction confirmation or statements, or often hidden within the product you purchase. They are typically a one-time cost when you purchase or are sold the product. These can be for most product or solutions offered, such as stocks, bonds, mutual funds, exchange-traded funds, you get the idea. If we go back 30-40 years, this was really the only option available to investors. You buy the stock or mutual fund and the commission, sometimes as high as 9%+, would be taken right off the top. So you’d stroke the cheque for $1,000,000, $90,000 would go to your advisor, and the remaining $910,000 would be invested in the fund. Yowzer! Going back in my career to the year 2000, when I first started out as a financial advisor working for a large global brokerage firm, we would sell front end load mutual funds where you would pay a 5% upfront commission. So if you were investing $1,000,000, $50,000 would be the commission, paid to my dealer of which I would get 40% and $950,000 would then be invested in the fund. Now in my defence, I didn’t have any other options back then, nor did I really know any better- that’s just the way it was. There was a benefit in that if the client purchased it this way they would receive a lower management expense ratio or MER on the fund. In some cases, for mutual funds, they may be sold with 0% up front or no-load commission and then the advisor would receive ongoing fees called trailers to continue to look after you- this is what you would typically see if you are just investing through your bank or credit union, which can lead to many thinking they don’t pay a fee.

Up until the last few years, many advisors used deferred sales charge otherwise known as the DSC. These were created back in the 80’s to help advisors sell mutual funds. Many people obviously didn’t like the idea of having to pay that upfront fee and not having all of their money go to work for them in the investment, so the fund companies came up with a way to still pay advisors that high up-front commission of 5 or so % but have the full amount invested. In this case, the investor would be stuck with the fund company usually for 7-8 years so that the company could recoup that commission paid through the management expense ratio. If the investor was to leave the fund company beforehand, they were faced with the sales charge that was usually on a sliding scale- so if you got out in year 1 you’d pay a 7% fee, year 2 a 6% fee, all the way through to year 8 where there would no longer be a fee. They also had the ability to draw out 10% each year without having to pay the fee to allow for some liquidity for those investors needing income. Many investors were not fans of having their investment tied up with a single company for that long so in the 2000’s the low load option became available which saw a smaller upfront commission in the range of 1-3% and investors only being tied up 1-3 years with the company.  On top of both of these up-front commissions, advisors would also get a trailer fee as well to continue to look after the client of half a percent in the case of the DSC and 1% in the case of the low load or no-load. So in that sense, there is kind of a mix in some of these products being sold where there is a commission but then ongoing fee to the advisor after that. As of June 1, 2022, regulators thankfully banned the use of DSC funds for mutual funds and June 1, 2023 for segregated funds, although some on the insurance side have come up with other ways to get paid up front, known as chargebacks, which again regulators have put a stop to.

If you are working with an insurance advisor, you are likely paying commissions, although they are almost certainly not transparent. Most insurance products, like life, disability, and critical illness policies, annuities, and segregated funds are commission-based products. So life insurance, as an example, pays an up front, usually fairly large commission to the advisor up front, usually 60-80% of the first year premium, and often with an override over and above that as well, and then ongoing reduced commission paid at annually.

Principal protected notes, bond, and even GIC’s sold through an advisor or broker will have an embedded commission paid out but the yield or quoted rate will already have that factored in. So if the GIC says you’re getting 5% you are getting the 5% and your advisor is getting paid a commission on it.

Now I’m not saying commissions are bad, in fact, if you’re needing insurance, which for many people is an essential part of their managing the risk in their financial plan, you have to work with an advisor who will be paid a commission. My issue with commission is where companies try to incentivize advisors, offering higher commissions, therefore causing conflicts of interest. In an ideal world these would all be disclosed and all would be good. Unfortunately, it’s not a perfect world. So, if someone is offering to work for free, chances are, they are being paid a hidden commission, just ask them to disclose how they’re paid and if they won’t find someone how will.

Okay, after all of that, we can now talk about the fee for service side of fees. This makes up the other member of the transactional fees. You will usually find this with fee for service advisors and planners. This can be ideal for those who invest on their own and are wanting a third party to do some planning or help to see if you’re on track with your goals. This is usually a limited engagement- hence why we include on the transactional side. You will typically know up front what the cost will be and what services will be provided for the fee. This is often quoted in a hourly fee or flat fee for the service and usually doesn’t include any products. Some of these advisors may offer products as well but often they just offer the planning services and leave it to another advisor or the client themselves to implement the plan. With this fee option you are typically cutting a cheque or having the fee charged to your credit card, which can make it less of an option for those younger folks or those starting out. Coming up with $2,000-5,000 for a fee when you’re just starting to invest a couple $100/month might not make as much sense to the individuals pocketbook. Again, it’s a great option to get a second opinion or get a plan that isn’t tied to products, but it can still come with some conflicts, such as the potential of the advisor dragging on the engagement to increase the costs. This I would think would be less likely. I would say the biggest drawback to this type of fee is the potential for folks to be hesitant to call for advice. Think of it the same way as your lawyer or accountant- you may have questions, but the answers come with billable hours meaning an invoice likely at the end of the conversation. The only other issue being that the implementation of the plan being left to the individual to get done- I’ve seen many folks over the years procrastinate when it comes to things like getting their wills and powers of attorney done, simply because the next step is in their hands to complete.

Now let’s cover the recurring fees, with the most popular option in Canada being the fee-based or asset-based method. This type of fee is transparent as you will see the amount deducted from your investment accounts on a monthly or quarterly basis. Historically 1% of assets has been a popular fee charged, so if you’re investing $500,000 the annual fee is $5,000 but you’ll see $416 be taken as the fee from your account if you pay monthly or $1,250 if charged quarterly. This fee will also have GST added to it and if the investment is in a non-registered account it may be tax deductible, this isn’t the case for registered accounts like the RRSP or TFSA as government figures their already providing some tax benefits on those accounts. Now the fee can be higher for small accounts, maybe at 1.25% or 1.5% and possibly being as much as 2%, but typically go down with the total more money you have invested, getting well under that 1% amount. Now by account I mean the investors household- so think husband and wife and any joint accounts- so this can include RRSP’s, TFSA’s, RESP’s, corporate accounts and so on. The total of all the assets is what the fees will typically be based one. Sometimes this fee is all inclusive of trading and admin fees but often that are on top of the fee. As well there is the product fee if you hold mutual funds or exchange traded funds /ETFs. One of the benefits of this option is that your advisor has some skin in the game so to speak, meaning if your account goes up the advisor makes more and if it goes down the advisor makes less- just like you.  However, a risk of this fee method is you could be working with someone who is taking the fee but not providing and value or service. This comes back to what we mentioned before- you have to find value in the fees you pay. Often the fees are quoted in percentage which can lead to sticker shock for folks when the see the actual dollar amount being deducted from their account, so it’s good to either ask your advisor or do the calculation before signing up.

Lastly there is the retainer or flat fee model in the recurring fees. This is hard to find in Canada at this point as very few advisors offer it. It can be beneficial in that you pay a flat fee, usually on a monthly or quarterly basis and again is paid via cheque, credit card, or direct debit from your bank account. This can result in it again possibly not fitting for those just starting out.  A nice part of it is that it’s disclosed up front, so you know your fees. The downside can be if your investments do go down in value for a period you could be in a situation where you’re paying the same fee even though you don’t have as much invested. Even worse could be if you lose a job or go through rough times with a business and right at the time when you need advice you don’t have the income to support paying the fee.

Now I’ve talked about the fees advisors are paid but we’ve missed out on the product fee. I’ve mentioned the management expense ratio or MER several times in this episode but haven’t explained what it is. I’ll save a more in-depth explanation for another episode but it is basically the cost paid to the company that is managing the fund. Part of the fee can be also paid to your advisor in the case of DSC or no-load funds but that cost is stripped out for the fee-based funds, known as F-class. Even everyone’s beloved ETF’s include this MER and it can include in some cases an embedded fee or trailer that is paid to your advisor. So this comes back to episode 2 where we talked about finding and working with a real financial advisor or planner. We’ll chat a bit more about that in our next episode.

I think that that covers our topic today. If you have questions or would like any retirement related questions answered on future podcasts please email us at info@awakenwealth.ca. Be sure to subscribe and give us a review on your favourite podcast player. You can also subscribe to the Wake-Up semi-monthly newsletter by visiting the Awaken Wealth site, which is awakenwealth.ca.

Be sure to check back in two weeks for our next episode where I’ll be wrapping up our now 4-part section on finding an advisor and answering the top questions you’ve asked.

Thanks again for joining us today and I look forward to seeing you back for the next episode.

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