A new, improved rip-off

Kelly Rodgers, MoneySense November 2000

Soon after I began my career in the investment business as a broker for Merrill Lynch Royal Securities, I was sent to New York for a training session. With 130 other new hires, I listened to a pep talk by Donald Regan, who was then chairman of the company. One of his comments is still etched in my memory. "Remember," he said, "when you get back to your offices, your job is to sell. It doesn't matter whether we're selling shoes or securities, your job is to sell!'

That was in 1979, but Regan's exhortation remains the most honest statement I have ever heard from a member of the brokerage industry. Despite what you may think, stockbrokers and financial advisers aren't in business primarily to dispense wise counsel, or to forecast the economy accurately, or to advise you on your personal affairs. Their most basic job is to sell you financial products.

Selling products used to be simple and very profitable for financial advisers. But consumers are getting smarter, and some financial planners are now promoting a new, improved approach to billing clients. They're moving away from "transaction-based fees" (where the adviser gets a cut from every product you buy) and toward "advice-based fees" (where you pay for financial advice).

In theory, this should be good news for consumers. Traditionally, financial planners have received a fee for almost every transaction they talk you into. For example, if they recommend a mutual fund, and you buy that fund, they get a sales commission. They also reap an ongoing "trailer fee"-a kind of retainer that mutual ftind companies pay to keep advisers recommending their funds.

Rewarding advisers this way creates big problems. For starters, it gives your adviser an incentive to continuously move you in and out of different financial products (an act known as "churning") since he or she is financially rewarded for every transaction. It also encourages advisers to recommend funds that pay them the highest trailer fees, rather than funds that might be the best investments.

If we move to a system where planners get paid for advice, that fixes at least one of these problems. Under the new system, a planner might charge you an annual fee ranging from 2% to 3% of your portfolio's value. Since most of his or her income now depends upon the size of your assets rather than the number of transactions you make, an adviser no longer has a big incentive to churn your portfolio.

This new system still has some glaring weaknesses, though. It doesn't dissuade advisers from recommending expensive products because advisers will still get paid trailer or service fees by the funds or products you invest in. And you may still be left in the dark about how much you're paying for advice. Sometimes, major costs-such as management expense ratios (MERs) on mutual funds, or administrative costs on investment products--aren't included m the adviser's fee. Those extra costs can exceed $2,000 a year on a portfolio of $ 100,000.

We need a system that is transparent. Ideally, an adviser would charge you by the hour to develop a financial plan. (The total charge for such a plan should be no more than $1,500 in most cases.) Your adviser would then list various ways to implement the advice - such as using mutual funds, index participation units or a traditional stock-and-bond portfolio - and state how much each option would cost you in terms of commissions, MERs or other fees. Finally, your adviser would outline an annual service charge - 0.5% to 1% of your assets - which you would pay him or her for ongoing advice and monitoring your account.

This would allow you to see exactly how much you're paying. In most cases, the all-in cost for advice and service, once you get past the initial consultation, should come to no more than 1.5% to 2% a year on a portfolio of $100,000. That would amount to $1,500 to $2,000. The percentage fee should decline as the portfolio grows.

This ideal hasn't arrived yet. Until then, you do have a Plan B: go to a fee-for-service financial planner who charges an hourly rate. These planners (full disclosure: I'm one of them) do not implement advice, so they have no incentive to recommend expensive products.

Unfortunately, fee-for-service financial planners can be hard to find. Start your search with a directory from The Canadian Association of Financial Planners (1-800-346-2237 or 416-593-6592 in Toronto; www.cafp.org). It tells you how each planner gets paid.