I sometimes jokingly say that my business card could bear the additional title of “translator”, since my contribution to the success of clients involves an educational role: explaining and popularizing the various investment statements and financial documents. Although various recent surveys reveal that the majority of investors believe that they pay too many fees on their investments, a minority of them are, in fact, able to clearly distinguish between the different types of fees.
Since 2017, with the second phase of the reform of the client-advisor relationship model, raising awareness among investors about the fees associated with their investments has been well underway. If, before, many of them were unaware that they were paying, the obligation of disclosure made to the industry has changed the situation. Media coverage of these significant regulatory changes has also made investors realize that they rightly need to better understand where their money is going.
Besides, “what are the costs?” has probably become the first question advisers have to answer, even before they can explain their recommendations. Has the swing of the pendulum tipped us from one extreme to the other?
A few ways to get there
This conversation about fees is necessary, albeit demanding, for both the advisor and the client. Regulatory obligations mean that there is a lot of information to be transmitted when opening an account or during a follow-up meeting, for example. Some advisors work with fees, others are paid by trailing commissions, which varies the management fees of the recommended products. Transaction fees vary from one financial institution to another. The possibilities are many and all have certain advantages and disadvantages depending on the type and size of the account. Here are some valuable definitions.
Management and operating costs. All funds have management fees, regardless of their structure (purchase fees, redemption fees), and they are presented in the fund facts. The published returns include these fees.
Fees. Some brokers use funds with reduced management and operating costs and charge clients themselves for managing the portfolio. You must therefore add the fees to the fund management fees.
Transaction fees. This category includes fees to be paid for wire transfers, for opening accounts, for transfers, for direct deposits, annual fees. They vary from one broker to another or according to the online platform.
Correlation between fees and return
This correlation is direct, in that every dollar paid in fees is one dollar less in return. It is therefore important to understand the impact of fees on performance. High fees do not equal high returns. However, I would also add that low fees are not more so. It is therefore more strategic to compare returns net of fees.
Thus, when building a portfolio, I believe that the selection of funds should not be based primarily on this selection criterion. For a higher management expense ratio (MER), some funds will still present a more attractive net return. It is therefore important to ensure that your “economic” portfolio performs better than that using funds with higher fees. If you are an independent investor, you may have already fallen into the trap.
Before you ask yourself if you are paying too much in fees, remember the reasons why you are doing so. Even Vanguard, a company renowned for its products with very low management fees, estimates that 3% of the return after fees and taxes is the potential value added by working with an advisor. The advisor’s alpha lies in their expertise for portfolio construction and wealth management (think rebalances or payout strategies, for example). It also consists of framing the behavior of the investor, who has a very (sometimes too) emotional relationship that makes him make the wrong decisions at the wrong time.
Beware of the temptation to think that, if the fees were zero, you would have a greater return (I will do a column on self-directed investing soon). Wealth management requires a whole team, structures and varied and multidisciplinary knowledge that have market value. The value you place on advice will vary, however, depending on your experience as an investor…
Finally, the annual fee report is a great way for you to educate yourself on all these fees. As an investor, however, you should devote just as much interest and time to understanding your investment policy.