I say bad, I mean bad

Kelly Rodgers, MoneySense September 2001

It's been a scorching summer for me, and the weather is only partly to blame. Most of the heat has been generated by the strong reaction to my last column. In it, I pointed out the potential problems in the new fee-only accounts offered by many financial advisers.

My argument is that these fee-only accounts can be a good deal for advisers, but they're not necessarily a good deal for clients. It's a matter of math. The all-in cost of money management under the traditional system was usually about 2.5% of your assets. These new accounts, however, can cost you up to 3.75%. They have the potential to substantially increase your fees without necessarily providing you with better service.

A lot of advisers didn't appreciate this line of thinking and besieged me with emails, letters and phone calls. I stand by my position.

To clarify, let me say that my column did not apply to any planners or investment counsels who just provide financial advice but don't sell products. After all, if people don't sell mutual funds and other investments, they cannot benefit from churning your account or selling you expensive funds.

Other criticisms fell into four categories. Let me answer each of them:

"Expensive, regular-load mutual funds would never be used in fee-only accounts. Only F-class funds would be used." Yes, advisers who charge a fee do have the option of selling their clients F-class funds. These are units of mutual funds in which the management expense ratio (MER) has been reduced by about one percentage point to offset the fee that the adviser is charging you separately for advice.

In theory, using F-class funds should allow an adviser to charge you a fee without increasing your overall cost of money management. However, in practice, you can wind up paying more when these funds are used. For example, if an F-class equity fund has a MER of 1.25% and your adviser adds a hefty service fee of 1.75%, you pay a total annual fee of 3%. That's considerably more than the 2.25% to 2.5% MER of most standard funds.

Also, I don't believe that fee-only accounts rely solely on F-class funds. I've met many people who are holding expensive load funds in a fee-only account.

"One shouldn't look at an adviser's costs without also looking at his or her returns." I disagree wholeheartedly, as do most personal finance experts. Costs and returns are directly related: as your costs go up, your returns come down-maybe not over the short term, but certainly over the long term. If vou want to read more on this topic, pick up anvthing by John Bogle. He's the founder of The Vanguard Group, a hugely successful mutual fund organization in the U.S., and he has done considerable research on lowcost investing. Many of his speeches are available for free at www.vanguard.com.

"The trailer fee on back-end load funds is 0.5%, not 0.75%." Correct. However, the trailer fee on front-end load funds is 1%. In my column, I averaged the two. In retrospect, I should have made this clear. Regardless, my point still stands: by selling you these load funds, advisers are getting paid twice and increasing their revenue in the process.

"Because of the column, advisers received calls from clients asking questions." Gosh. If my column prompted you to call your adviser and ask a fev questions, then I consider it a success.

Now you may wonder what I believe is the ideal system for paying an adviser. The answer is really very simple. I believe in total transparency. Financial advisers should make it clear exactly how you are paying them-and no fee should be hidden or sneaky.

I am happy to acknowledge that fee-only accounts aren't necessarily bad. If a fee-only account is priced fairly, and you are receiving decent service from your adviser, then fee-only arrangements can be an attractive alternative to a transaction-based system in which your adviser reaps money for selling your products.

It all comes down to cost. For accounts up $250,000, you should pay no more than 2.5% of your assets a year, including the MERs on your mutual funds and your adviser's annual fee. For accounts between $250,000 and $500,000, the total cost should not exceed 2.25%. If your account is over $500,000, the total cost should be no more than 1.75%.

Anything more is just plain greedy.