Ok so we have all seen the commercials on TV where the arrogant looking advisor is being confronted by the disgruntled client. They are good commercials because they get you to focus on the fees associated with investing and suggest that you move to a lower fee based set of investments offered from the company paying for the advertisement.
Have you ever sat down and analyzed the message? I have and here are my comments regarding the various fees associated with an investment. There are two common items to a fee structure being proposed: (a) The load; (b) the management expense ratio (MER); and (c) fee for advice.
The load is the cost of either entering the fund or leaving the fund. It starts at 0% and can go as high as 7%, although most maximums are 5%. The load is either removed at the time of deposit or is removed if you withdraw funds prior to the end of the load schedule. There are four typical load structures to any type of load-based investment (as opposed to straight fee based):
No-Load (NL) – in this situation there is no loads applied against the investment either at the beginning or at the withdrawal of money.
Front-End Load (FEL) – in this situation, a fee is charged for each and every deposit made to the investment. The load can be 0% or higher, but typically no more than 1-2%.
Low-Load (LL) – in this situation, a fee is charged in the event that you withdraw your funds within a period of time – typically 3 or 4 years and the load decrease to 0% over that timeframe.
Deferred-Sales Charge Load (DSC) – this situation is exactly the same as the LL option but the length of time is greater and usually is up to 6 or 7 years and again with a decreasing amount to 0%.
The MER is a measure of the total cost associated with the fund as a percentage. This is how the consumer pays for the advice, expertise and overall management of the investment in question. The MER is the focus of the commercials that I discussed above. Although the MER is important when assessing the viability of an investment, it should not be the primary focus of the decision.
Fee-for-advice is the term used when the consumer pays a fee separate from the MER of a fund. It is usually related to the services provided by the advisor and can be a flat fee or a percentage of assets being managed by the advisor. Someone who works with an advisor this way should add the fee cost to the MER of the underlying investments being used when trying to compare costs associated with an investment portfolio.
At the end of the day, the cost as a whole of investing is far less important than the returns that are being obtained net (after) of fees. For example, if you have a fund that has a MER of 2% and a long-term rate of return of 7%, then the net is 5%. If you have a second fund that has a MER of 4% and a long-term rate of return of 10%, then the net is 6%.
The commercials on TV and those who invest their clients’ money in ETFs and charge a fee both focus on the MER. With that strategy, the first fund above would be the fund they are recommending as 2% is lower than 4%. A proper financial advisor, however, looks at all factors and gives more credence to the net return of the fund in question and would therefore be recommending the second fund above.
Moral of the story: There is a reason the commercials and many others focus on the MER & fees.