A bad deal gets worse

Kelly Rodgers, MoneySense July 2001

There is a new way to pay your financial adviser. It's called a "fee-only account," and it's being touted as a great alternative to what is often a bewildering process for investors. Problem is, while most payment options for financial advice are deeply flawed, this new one is even worse.

The sales pitch is simple: with a new fee-only account, you pay your financial adviser only one annual fee, which covers all the trading, service and financial planning that he or she provides you. This fee ranges from 1.5% to 2% of your assets, depending on the size of your account; the larger your account, the lower the rate. On a $100,000 portfolio (which is typically the minimum portfolio size for this type of account), fees range from $1,500 to $2,000 a year.

We're told that this approach aligns your interests with those of your adviser's. You no longer have to worry that your adviser might pad his or her wallet by encouraging you to do unnecessary trading. Nor do you have to be concerned that your adviser will sell you overpriced products such as expensive mutual funds.

Best of all, according to proponents, this scheme ensures that yOU get service, since this is the only way your adviser will make money. In fact, these accounts are marketed to investors whose most common complaint is that they never hear from their adviser until they get a call asking for an RRSP contribution.

The pitch sounds good, but I see nothing but trouble when I look closely at fee-only accounts. In an increasingly competitive marketplace, where investors are asking more questions and demanding better service from their financial advisers, these accounts are just a clever way for advisers to increase their income at your expense.

Let me show you just what sort of deal is being offered here. A recent survey in Advisor's Edge magazine showed that brokers earn an average of 0.9% per year and financial planners an average of 1.1% per year on the assets under their administration. For our purposes, we can round each number to 1% and refer to both brokers and planners as financial advisers. This means that the average financial adviser earns about $1,000 for every S100,000 he or she administers.

Most of this money is earned from transaction-based fees -in other words, the cut that an adviser receives from almost every product you buy. For example, if you have a mutual fund in your RRSP, your financial adviser probably received a 5% commission from the mutual fund company at the time the fund was purchased. In addition, he or she is probably collecting an ongoing annual "trailer fee" of about 0.75%. This is a fee that mutual fund companies pay to keep advisers recommending their funds.

While the percentages may not sound particularly onerous, the dollar amounts add up. On a $100,000 mutual fund portfolio, your adviser likely receives $5,000 in commissions when yOU purchase the funds, and an additional $750 every year in trailer fees. Over a decade that's $12,500 of your money that goes into your adviser's wallet.

Now let me show you what happens when you compare this traditional way of paying financial advisers with the "new and improved" fee-only account. First, the issue of trailer fees is still here, despite the sweet-sounding marketing pitch. So far, I haven't seen anything to suggest that your mutual fund fees will be reduced by the amount of the trailer fees-which means that you're probably still paying them.

This also means, that your adviser's income could easi1y rise from 1% to 2.25% (0.75% in trailer fees plus his or her new advice fee of at least 1.5%). That's more than double the old income. On a $100,000 portfolio, this additional cost adds up to $25,000 over 20 years.

That's a great deal for your adviser, but not for you. Your total costs are now 1.5% in adviser fees and 2.25% in management expense ratios (MERs), which is the average annual cost of owning a mutual fund. That adds up to a grand total of 3.75% - or $3,750 a year on a $100,000 portfolio. This is outrageously high and will gut your returns over the long term.

In other words, these new fee-only accounts are new and improved only for your adviser. If he or she approaches you about this type of arrangement, think about it very carefully. Get your adviser to spell out exactly what sort of service you'll be getting and what fees will be included in the price. If trailer fees and funds with high MERs remain on your bill, then either say no to the deal or find another adviser.