February 17, 2017 – Anyone who has ever gone to a garage to have work done on their automobile will know that the shop usually provides the customer with an itemized bill of the work to be done with the two primary line items being the estimated cost of labour and the exact cost of whatever parts are required. As a rule, work only begins once the vehicle owner signs off on these estimates.
Many people believe that the financial services industry – particularly the participants that recommend mutual funds – would be well-served by offering a similar way of breaking down the cost of the total package into simple, itemized portions. To begin, it needs to be recognized that both financial products and financial advice cost money.
Don’t ever let anyone suggest to you that they are “free” or “paid by someone else”. In the case of traditional mutual funds, that combined cost is known as the Management Expense Ratio (or “MER”).
All mutual funds publish their MER in both the prospectus and the Fund Facts disclosure documents, so the information is available for those who care to look it up. The problem, as you might imagine, is that the MER is a total number that does not break down how much of the cost (which is entirely paid by the investor) is for the product and how much is for advice. Stated a bit differently, the cost of advice is embedded into the total cost to the client as a portion of the MER.
The provincial regulators across Canada released a discussion paper earlier this year that asks participants about how they would go about banning trailing commissions (the cost of advice portion of the MER). In the meantime, new rules require that client statements disclose the amount of money paid to the advisor’s firm in dollar terms. In short, there are documents that spell out total cost, but these often fail to itemize the cost of advice. There are also statements that are mailed to clients that spell out the cost of advice, but those statements do nothing to explain the corresponding product costs.
Why do consumers have to look at separate pieces of information in order to get the same kind of basic, line by line information that anyone can get one a single piece of paper at a reputable garage? Everyone understands the basic idea of knowing how much the parts (investment products) cost and how much the labour (financial advice) costs. Unfortunately, in 2017, the financial services industry still does not offer a similar breakdown in dollar terms and in advance.
The concern here is not primarily about the cost of advice or the cost of the products. Rather, the concern is that many advisors use a business model where the cost of advice is buried in the total client cost. This way of doing business might mean that there are other products that are cheaper or better (or perhaps even both) that advisors might not recommend – simply because those products don’t feature an embedded compensation option. Your advisor’s choice of business model should never be the primary driver of the product recommendations made to clients. Rather, product recommendations should always be made on the basis of merit and suitability. There are many people who feel that the best way to ensure advisor independence is to only work with someone who you pay directly. That way, there is no need to question that person’s motives.
John De Goey is a Portfolio Manager with iA Securities (iAS) and the author of The Professional Financial Advisor IV. His website is: www.johndegoey.com. The views expressed are not necessarily shared by iAS.