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Fee-Based Advisors May Not Always Be More Ethical By Default

 

Fee-based financial advisors generally operate using what are called fee-based accounts in which a client advisory fee is charged separately, and mutual funds with embedded trailers are not used. Rather, if using mutual funds, they will use a special unit class of the funds, known as f-class units which have no trailer fee. (If the advisor is an IIROC licensed advisor, they also have the ability to buy stocks and bonds without charging transactional commissions [stocks] or without eating into the spread [bonds]). The advisor’s compensation is derived from the client advisory fee.

For example, if a mutual fund has an MER of 2.5% and it paid a trailer of 1.00% to the advisor, it could also be available as an F Class version with an MER of 1.5%. The advisor may choose to charge a client advisory fee of 1.00% separately. In the end, in a non-taxable account the cost to the investor is the same (the client advisory fee can be tax-deductible in taxable accounts), but there is definitely more transparency which is great.

A lot of people indicate that the fee-based account is better than the transactional, traditional advisor – but this is not always the case.

For example, I know that some advisors can actually take advantage of the ability to set their own fees. At my old brokerage, we had the lattitude to select the fee schedule – it could be tiered based on assets, a flat-fee on all asset levels or asset classes, or it could be tiered on asset levels differently for different asset classes (i.e. equity versus fixed income). It would be possible to charge more than 1.00%. In fact, it could be significantly more.

Let’s say an advisor runs into a client who has a mutual fund wrap with a cost of 3.00% (current advisor collects 1.25% trailer). They could save the client money by using a fee-based account with ETFs to replicate the asset allocation with a product fee of 0.35% and safely charge 1.75% as the client advisory fee and still look like heroes if the client is sensitive to overall costs (the savings would be almost 1% to the client, but the income to the advisor would be 40% more).

A more simple example would be an investor who buys and holds stocks. They would’ve been better off using a transactional approach since while the fees would be front-loaded, over longer periods of time they would be paltry versus a fee-based approach.

Anyways, my point is that the simple label of “fee-based advisor” does not necessarily mean a better advisor.

Related posts:

  1. Fee-Only versus Fee-Based… Continued
  2. Fee-Only Based on Net Worth, not Portfolio Size
  3. Faith-Based Investing

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About Preet

Preet Banerjee is a Canadian personal finance commentator. He is a television host for The Oprah Winfrey Network, a Money Expert for The W Network, a personal finance columnist for The Globe and Mail, and a regular panellist on CBC's The National with Peter Mansbridge. He also appears frequently as a guest commentator on a variety of other programs and media.

Comments

  1. Good points.

    But appearances count for something. And when an advisor collects commissions, it’s possible that the client’s needs come second.

  2. Jordan says:

    Preet, I think as an advisor advocate you should buy the domain RateMyAdvisor.ca and set it up like RateMyTeachers.com. Scores 1-10 for various attributes of their skill, ability, personality, honesty, fees, and anonymous reviews.

    Since there appears to be few ways for the average investor to know if an advisor is any good or has any chance of adding value this could serve as an unbiased source of confidence.

    Sure it might be gamed or abused a bit, but think of Amazon reviews, for the most part they are an excellent tool to pick between similar products.

    RateMyMutualFund.ca can come next!

  3. Preet says:

    @ Mark Wolfinger – no argument there!

    @ Jordan – ratemyadivsor.ca and ratemyfinancialadvisor.ca were already registered, but that would be a great idea. Conflicts too much with my day job right now for me to personally do it, but boy it sounds like a fun idea! :)