This article compares the likely effect of choosing different types of advisors for drafting a financial plan and managing your investments on your portfolio’s future value. The differences can be substantial and more so the more current assets you have. Keep in mind that individual financial advisors or a combination of them not necessarily will yield the same magnitude of difference; nevertheless, on average, the variations are likely substantial.
By way of their compensation, there are four types of financial planners: primarily commission based, primarily asset-based, mixed commission and asset-based and fee-only financial planners.
Traditionally, financial planners offer “free” financial planning with the expectation that by implementing their financial plans for prospective clients they will either earn a specific percentage commission on the financial products they sell to their clients or will be compensated as a percentage of their clients’ assets on an annual basis or a combination of these two.
One type of financial advisors who might devise financial plans are the exempt market dealer representatives regulated by their respective provincial (or territorial) securities commissions. They are primarily compensated by commission earned on the trades of the financial investment product they sell. Their commission rates typically range between 4.00% and 12.00%. They may also be compensated by annual trailer or service fees on the assets they sold and are administering, but usually, this is a small portion of their earnings.
Portfolio managers are strictly compensated based on the assets they manage, generally charging between 1.00% and 2.00% annually depending on any particular client’s assets they manage.
The mixed commission and asset-based financial advisors are also frequently offering “free” financial plans to their prospective clients and will get compensated by a commission at the time of the sale of the financial products they offer plus as a percentage of the assets they manage for their clients. Many of the mutual fund advisors regulated by the Mutual Fund Dealers Association of Canada (“MFDA”) and many of the brokers regulated by the Investment Industry Regulatory Organization of Canada (“IIROC”) are compensated according to this compensation model. The gross commission what these types of advisors make is typically ranging between 3% and 6% and annual service, or trailer commissions vary between 0.40% and 1.00%. Usually, the more the commission rate is, the less the service fees are and vice versa. These financial advisors can be MFDA regulated mutual funds advisors, or IIROC regulated investment advisors.
Frequently mutual fund companies offer each of their products in different classes depending on the financial advisors’ fee structure. Class A mutual funds pay either a gross 0.50% or 1.00% service or trailer fees to the financial advisors, and Class F funds do not pay any amount. This is because financial advisors investing their clients’ assets in Class F mutual funds bill the client directly for their fees (usually 1.00% a year). For this reason, Class F mutual funds always have lower management expense ratios (“MER”) compared to those of Class A funds. Typically this difference is 1.10% (1.00% plus HST) between the otherwise identical mutual funds’ Class A and Class F versions.
Asset-based financial advisors do not earn any commissions on the sale of financial products. They are either paid an annual service or trailer fee between 0.50% and 1.00% gross on their clients’ investment in Class A type of mutual funds by the mutual fund companies or they directly charge a set percentage annual fee to their clients on the assets they advise their clients on. In the case of the latter, they usually use Class F mutual funds.
A growing number of asset-based advisors charge a set percentage annual fee on the assets they manage for their clients. Typically they advise on mutual funds and charge 1.00% yearly fee for their services paid by their clients, and they are not paid any service fees by the companies whose products they use. As mentioned above the mutual funds they typically use are F Class.
On the other hand, fee-only financial planners charge either a fixed amount for the preparation of the initial financial plan and also charge a fixed annual fee for the annual reviews or, less frequently, charge by the hours they spend on the financial plans. Regardless whether they charge a fixed or hourly rate for their work, fee-only financial planners generally bill $800 to $2,500 for the initial plan and between $500 and $1,500 annually for their reviews. Fee-only financial planners could also be compensated by financial advisors whom they refer their clients to implement their financial plans. Clients have a choice to deal with any financial advisor to fulfill the financial plans they receive from their fee-only financial planners. They could use financial advisors their fee-only financial planner has a relationship with or choose any of the other financial advisors or could opt to implement their financial plans on their own.
Table 1. summarizes the range of compensations what different types of financial advisors typically earn by providing financial advice to their client. The reader should note that the below fees are only showing what the advisors are making gross and do not include the management fees and expenses the companies whose products the investors invest in.
Table 1.
Types of Financial Advisors and their Compensation
| Type of Financial Advisor: | Mainly Commission based EMD representatives: | Commission based MFDA/IIROC financial advisors: | Asset-based MFDA/IIROC financial advisors: | Portfolio Managers: | Fee-Only Financial Planners: |
|---|---|---|---|---|---|
|
Gross Commission Rate on the sale of investment products: |
4.00% - 12.00% |
3.00% - 6.00% |
0.00% |
0.00% |
0.00% |
|
Gross Annual Trailer or Service or Management Fee: |
0.00% - 0.20% |
0.50% - 1.00% |
1.00% |
1.00% - 2.00% |
0.00% |
|
Initial Gross Fee: |
$0 |
$0 |
$0 |
$0 |
$800 - $2,500 |
|
Annual Gross Review Fee: |
$0 |
$0 |
$0 |
$0 |
$500 - $1,500 |
In many cases, commissions and annual fees are embedded costs in the financial products financial advisors are selling and/or managing for their clients. Although there are other possible financial products than mutual fund types, nevertheless these types of investment funds in total account for $1.64 trillion or 38% of Canadians’ financial wealth as of January 31, 2019 (source: IFIC) and therefore for most of the investors they form a core or only financial investment they invest in other than their principal residence.
Obviously when investors go to any of the above types of financial advisors to advise them how to achieve their financial goals the plans what they would receive need to be implemented and therefore an accurate, correct comparison among the costs of financial plans’ and their implementation costs need to be analyzed.
As covered earlier in this article Class A mutual funds are the type of investments the investment company pays an annual service fee to the financial advisor. Class F mutual funds have lower MER’s as the investment companies do not pay the financial advisors any service fees on assets invested in these types of mutual funds. According to Investor Economics: “Median MERs of Canadian Series A mutual funds in 2013” the MERs of the different types of mutual funds are the following:
Table 2.
Types of Mutual Funds and their Median MERs
| Type of Mutual Fund | Median MER (Class A) |
|---|---|
|
Canadian Money Market |
0.75% |
|
Canadian Fixed Income |
1.60% |
|
Canadian Neutral Balanced |
2.35% |
|
Canadian Equity |
2.48% |
|
Global Equity |
2.59% |
I believe that median MERs did not change much since 2013 and also that most investors more or less invest according to a neutral balanced allocation. Consequently, I assume that Canadian mutual fund investors pay around 2.35% annually including their financial advisors’ fees.
From the above information and assumptions equity and fixed income types of investors on average pay the following annual fees to their advisors depending on the type of advisors or combination of types of advisors:
Table 3.
Estimated Combined Costs for Financial Plan & its Implementation
| Type of Advice | Commission based MFDA/IIROC financial advisors: | Asset-based MFDA/IIROC financial advisors: | Fee-Only Financial Planner + Portfolio Manager: |
|---|---|---|---|
|
Gross Commission Rate: |
3.00% - 6.00% |
0.00% |
0.00% |
|
Combined Annual (mutual fund company and advisors’) Fees: |
2.35% |
2.35% |
1.00% - 2.00% |
|
Initial Gross Fixed Fee: |
$0 |
$0 |
$800 - $2,500 + HST |
|
Gross Annual Review Fee: |
$0 |
$0 |
$500 - $1,500 +HST |
Now we have all the elements we need to summarize our analysis for a large share of clients. However, before we do draw our conclusion, we need to make some reasonable assumptions. These are:
- There is no difference in knowledge and skills of among all the advisors and/or combinations of advisors; and
- If dealing with a commissioned advisor his/her advice will not be influenced by differences in commission rates of different financial products; and
- If dealing with a commissioned advisor, the commission rate is assumed to be 3.00%, and initially, commission would be paid based on the whole initial portfolio and in subsequent years it would only be paid on new investments. Furthermore, the commissions are assumed to be embedded in the financial products they sell; and
- Portfolios managed for clients have an MER of 2.35% per year including advisors’ management/service fees, if any, regardless of advisors except for portfolio managers; and
- Portfolio managers’ annual management fees are 1.75% for portfolios between $100,000 and $250,000, 1.50% for portfolios between $250,000 and $500,000, 1.25% for portfolios between $500,000 and $1 million, 1.10% for portfolios over $1 million and they don’t manage portfolios that are less than $100,000; and
- Average annual gross portfolio performance is assumed to be 7.00% regardless of advisors; and
- The fee-only financial planner’s initial fee is assumed to be $1,200 and $800 per annum in subsequent years.
- The fee-only financial planner’s annual review fees are assumed to increase by 2.00% inflation rate annually.
We will be calculating and comparing total combined management and financial planning expenses, and managed portfolio values over 25 years engaging MFDA/IIROC advisors and a combination of Fee-Only financial planners with portfolio managers. The results are shown in Table 4.
Table 4.
Comparison of Portfolio Values using an MFDA/IIROC advisor vs. Fee-Only & Portfolio Manager
| MFDA/IIROC Advisor: | Portfolio Manager + Fee-Only Financial Planner: | Difference in Value: | Percentage Difference in Value: | |
|---|---|---|---|---|
|
Portfolio Value at start: |
$100,000 |
$100,000 |
|
|
|
Annual additions/withdrawals: |
$5,000 |
$5,000 |
$33,182 |
6.16% |
|
Portfolio Value in 25 years: |
$538,953 |
$572,135 |
|
|
|
|
|
|
|
|
|
Portfolio Value at start: |
$250,000 |
$250,000 |
|
|
|
Annual additions/withdrawals: |
$15,000 |
$15,000 |
$285,845 |
19.56% |
|
Portfolio Value in 25 years: |
$1,461,102 |
$1,746,946 |
|
|
|
|
|
|
|
|
|
Portfolio Value at start: |
$500,000 |
$500,000 |
|
|
|
Annual additions/withdrawals: |
$25,000 |
$25,000 |
$669,519 |
24.85% |
|
Portfolio Value in 25 years: |
$2,694,766 |
$3,364,285 |
|
|
|
|
|
|
|
|
|
Portfolio Value at start:
|
$1,000,000
|
$1,000,000
|
|
|
|
Annual additions/withdrawals: |
$50,000 |
$50,000 |
$1,450,059 |
26.91% |
|
Portfolio Value in 25 years: |
$5,389,532 |
$6,839,591 |
|
|
|
|
|
|
|
|
|
Portfolio Value at start: |
$2,000,000 |
$2,000,000 |
|
|
|
Annual additions/withdrawals: |
-$120,000 |
-$120,000 |
$1,062,867 |
137.71% |
|
Portfolio Value in 25 years: |
$771,841 |
$1,834,708 |
|
|
The above table demonstrates that dealing with a Fee-Only financial planner + portfolio manager will likely make a substantial difference in your wealth over time, and the percentage difference in portfolio values are increasing with the value of the initial portfolio. In other words the more money you have, the higher the apparent advantage will become.
Of course, there are differences in financial advisors’ abilities and attention to your portfolio. It is possible that any one MFDA/IIROC advisor will better serve a client’s needs than a combination of a Fee-Only financial planner and a portfolio manager. However, differences in compensation structures, conscious or unconscious bias due to commissions rates and/or service fees differences among financial products and also possibly in competence levels makes it considerably more likely that you as a client would end up better off using a combination of a Fee-Only financial planner and portfolio manager.
To ask any question about this article or to book an appointment to look at your particular case, please contact Miklos at nagy@fin-plan.ca. Miklos is a fee-only financial planner, best selling author, finance-related educational course writer, statistician and former Chair of the Canadian Institute of Financial Planners with over 25 years of experience in financial planning for high net-worth and middle-class Canadians. His Fee-Only financial planning website is at www.fin-plan.ca and his Linkedin page is at https://www.linkedin.com/in/miklos-nagy-fee-only-financial-planner/.
Copyright © 2019 by: Miklos A. Nagy
The views expressed in this material are the opinions of Miklos A. Nagy through the period ended 03/28/2019 and are subject to change based on market and/or other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk, including the risk of loss of principal. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
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