Douglas Nelson: Investment fee disclosure coming

The Canadian Securities Administrators (CSA), the umbrella group for provincial securities commissions, recently submitted a proposal for review that would require all mutual fund dealerships to provide an annual summary to each client of the fees and commissions paid to the dealer and to the client's advisor as a result of the client's account. The goal is clear and open disclosure ó and a better-informed client.

For many years now, fee disclosure has been hotly debated and Canada has joined the discourse. In Australia and the United Kingdom, for example, imbedded trailing commissions in mutual funds have been banned or significantly modified. But, although the CSA proposal to disclose these fees appears practical in comparison, some advisors may take exception to the proposal.

After all, in many businesses, the consumer is never privy to the profit margin or commissions paid to the salesperson. A classic example is a car dealership. While a consumer can negotiate the price of the car with the dealer, the consumer never really knows how much profit the dealer is making. Alternatively, when working with a real estate agent, it is clear from the start what the commission is likely to be should the agent sell your home for you.

So, what are the implications of the CSA proposal? Regardless of your viewpoint, there are some interesting implications:

ï The 80/ 20 rule. I fully expect that fee disclosure will be a non-issue for the vast majority of investors. The reason for this is simple: small to mid-sized investors are being subsidized by the largest investors.

For example, Investment Executive research found that the average assets invested per family household was $190,000. Assuming that was invested in mutual funds, for which the advisor received a 1% trailing commission from the fund company, the account brought in $1,900, of which the advisor typically receives $1,425 or 75% with the rest going to the dealer.

Although this is the average, 85% of the assets overseen by the advisors surveyed were in accounts of less than $500,000 and only 15% of their client accounts held investments greater than $500,000. Applying the 1% commission, the gross fee on a $500,000 account is $5,000, of which about $3,750 goes to the advisor and $1,250 goes to the dealer. But with 85% of accounts less than $500,000, the advisor would be making considerably less than $3,750.

So, is the fee associated with the client reasonable given the size of the investment account? The answer to this question will be different for each client, but looking at this fee in the context of a professional, hourly wage, the fees could be increasingly difficult to justify the larger the client account. For example, based on a professional hourly fee of $300 an hour, $3,750 represents 12 hours of work on this client's file each and every year. Can this amount of time be easily demonstrated to the client, particularly in a sideways- or downward-moving market? In this same survey, 32% of the advisors' clients had investments valuing less than $100,000. This means that the advisor would receive $750 or less a year for each account.

To go back to my original point, it appears larger client accounts have been subsidizing the smallest client accounts. The good old 80/20 rule is alive and well in the financial services business with the largest 20% of clients providing 80% or more of the advisor's income. But what happens to the advisor's business model when the largest 20% no longer feel comfortable with the fees they are paying?

ï The impact on financial planning services. Today, many advisors provide financial plans to clients free of charge.  Although this appears to be of great value to the consumer, in fact, it can be argued that it causes greater confusion. The "freeî financial plan is really being subsidized by the trailing commissions paid by the fund company to the advisor for money invested on the client's behalf.

So, what is the real cost of providing professional financial advice? Is the cost of this financial plan a couple of hundred dollars or is the real cost several thousand dollars? Based on the figures above, if the client has more to invest, then it would seem that this client is paying more for the same financial plan than the investor with less money to invest.

You could also argue that, by providing a "freeî financial plan, financial services firms are placing less value on their own advice. Whether a plan costs $500 or $5,000, this value is something that should be easily demonstrated to the client.

ï The impact on the discount brokerages. Some discount brokerage firms on occasion allow clients to purchase only mutual funds or exchange-traded funds that have imbedded trailing commissions, those same commissions the CSA wants dealers and advisors to disclose. As a result, the client pays a higher annual management expense ratio (MER) than he or she would if the client had access to a low-cost, "f-classî mutual fund. With an f-class unit, the client escapes the imbedded mutual fund commission that, in this case, is flowing to the discount brokerage to subsidize the cost of trading.

By disclosing these fees, one outcome may be increased trading costs at discount brokerage firms. In other words, we may very well see once and for all what the real cost of transacting in this environment is.

Over the past 10 years, I have been associated with Evelyn Jacks and the Knowledge Bureau and have been involved in the development of several self-study courses. The main theme of each course is the "systemizationî of important processes that will add hundreds of thousands of dollars of wealth to clients over time. In other words, the actual rate of return on the portfolio pales in comparison to the benefits of structuring your own or your clients' affairs on a tax-efficient basis. By paying attention to the "eroders of wealth,î by layering income tax-efficiently, by following important rules and principles year in and year out, and by focusing equally on the four elements of Real Wealth (accumulation, growth, preservation and transition), you can build an amazing amount of wealth over time with considerably less risk.

For those clients with more than $500,000 to invest, these services and strategies will mean the difference between success and failure. As I have implemented these strategies with my clients in my practice, I have found that clients simply do not need to take as much portfolio risk as they do today.

While the proposed disclosure of imbedded commissions may be a short-term disruption to some advisors and a non-event to the majority of investors, the good news is that this change may also trigger a revolution in financial-advice giving. As the saying goes, "Be wary of discounted advice when i) buying a parachute, ii) getting your brakes fixed and iii) receiving financial advice.î

Douglas Nelson, CFP, CLU, MFA is the author of Master Your Retirement: How to fulfill your dreams with peace of mind. A financial planner in Winnipeg, Nelson specializes in Real Wealth Managementô in the areas of retirement income planning, business succession and portfolio construction.