Never let your guard down when dealing with the financial industry, even when it's offering something as supposedly client-friendly as the fee-based account.
In theory, fee-based accounts give advisers a transparent, above-board way to answer the question of how much they charge for their services. Instead of paying commissions buried in the cost of investment products, clients pay annual fees equal to a percentage of the value of their account plus any costs associated with the investments they hold.
Ask a fee-based adviser what his or her fee is and you'll have no problem getting an answer. What you may not be told is that:
-There are "list prices" for fee-based accounts and real-world, negotiated fees;
-Fees vary widely from adviser to adviser;
-Fee-based accounts could cost you more than a commission-based account.
A report on pricing in fee-based accounts was recently completed by PriceMetrix, a software firm that specializes in helping advisers improve productivity. The conclusion for investors trying to make sense of the fees charged in fee-based accounts: "It is an opaque market," PriceMetrix president Doug Trott said. "It's like buying a Persian rug."
Investors are going to have to become familiar with fee-based accounts because they're gradually taking over in the advice business. The analysis firm Investor Economics reports that the share of fee-based assets had grown to 48 per cent in the full-service brokerage business as of March 31 from 36 per cent five years ago.
PriceMetrix said advisers are converting existing clients to fee-based clients to a limited extent. The big emphasis is on getting new clients to adopt this type of account instead of the more traditional commission model.
Stay open-minded when an adviser pitches a fee-based account to you. If advisers lock in a stream of fees from a client, they shouldn't be tempted to put juicy commissions ahead of client suitability when recommending products or strategies. The fee-based arrangement also suggests you'll get continuing advice and planning. Just as the fee is out front in the fee-based model, so should the level of service.
But what about the fee itself? What investors need is some context to judge the fees they're being asked to pay.
PriceMetrix found that investors in Canada and the United States pay 1.32 per cent on average (the two markets are very similar), but account size has a huge impact on your actual cost. With household assets of up to $100,000, PriceMetrix found you could be asked to pay as much as 2.12 per cent on average. At $500,000, you might be asked to pay 1.84 per cent.
But those are "scheduled" fees that an investment firm will publish for the sort of rube who pays full list for a car. Actual fees range from 1.68 per cent on average for households with assets up to $100,000 to 1.32 per cent for those with between $500,000 and $1-million.
These average numbers hide the fact that fees can vary by as much as one percentage point from firm to firm, which is a huge margin. "The price is all over the map and the reason, I'll hypothesize, is that there's a lot of supply but very little competition," Mr. Trott said. "If there was fierce combat on fees, you'd find more of a common price for similar services."
Still, PriceMetrix says the cost of fee-based advice declined steadily between 2007 and 2009, before levelling off in 2010. The firm said it's very difficult for advisers to raise the cost for existing clients, although they can pass along higher fees to newcomers.
With a commission-based account, it can be difficult to know how much you're paying in fees because they may be buried in the cost of buying and owning products. Still, it's quite possible that paying commissions will cost you less than a fee-based account.
PriceMetrix found that investment firms were able to generate almost twice as much revenue from households using fee-based accounts as they were with clients in other types of accounts. Mr. Trott said this gap is partly explained by the fact that households using the fee-based model tend to have more and larger accounts with their adviser. PriceMetrix found that average household assets for people in fee-based accounts is $728,000, compared to $256,000 for households not using fee-based accounts.
But fee-based advice can also be expensive for clients without big needs. Examples: You have a buy-and-hold portfolio of stocks that doesn't change much from year to year, or you hold mostly bonds or guaranteed investment certificates. In the United States, there have been some notable abuses of investors, particularly seniors, who paid fees that appeared outrageously out of whack with their needs.
PriceMetrix found that pricing of fee-based accounts is to some extent influenced by the kinds of investments a client holds. Using households with assets of $250,000 to $500,000 as a base, it found that portfolios heavy on stocks cost an average of 1.39 per cent, balanced portfolios cost 1.21 per cent and bond portfolios cost 1 per cent. With a five-year bond or GIC paying no more than about 3 to 3.5 per cent, a fee-based account that costs 1 per cent annually is prohibitively expensive.
To properly understand the cost of fee-based advice, you must also consider the fees associated with products held in your account. For example, you might pay 1.25 per cent in account fees and another 0.15 to 0.65 per cent to own a portfolio of exchange-traded funds. F-class mutual funds – they're lower-cost funds specifically designed for fee-based accounts, might add 0.5 to 1.5 per cent.
If you get a high level of service that includes financial planning, the cost of fee-based advice can be a good value. But that message doesn't seem to be getting through to investors.
The Boston-based research firm Cerulli Associates surveyed 7,800 households last year and found that about 47 per cent preferred to pay commissions for financial advice, while 27 per cent said they like paying a fee based on assets. More clarity on the fees that go into fee-based advice might help turn those numbers around.
FACTS ON FEES
In a fee-based advisory account, you pay a percentage of your assets to your adviser and dispense with commissions attached to the purchase and sale of investments. Here's what you need to know about fee-based accounts:
1 to 2 per cent per year in very rough terms, with large accounts at the low end.
Quarterly or monthly and deducted from your account unless you request otherwise.
Ideally, fees and commissions associated with buying investments, plus advice from your adviser.
What's not included
The cost of owning investments such as mutual funds and exchange-traded funds.
All types of advisers and firms.
Exchange-traded funds work well because they add only a small cost to the fee charged by the adviser; low-cost F-class mutual funds are also an option, as are stocks and bonds.
Most suitable for
Investors who want their adviser to be actively involved in running their portfolio and who want broader financial advice on a continuing basis.
May not be suitable for
Investors who have a buy-and-hold portfolio that needs little oversight, or who have mostly bonds or GICs in their account.
Fees related to investment advice can be tax-deductible in a non-registered account.
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