When it comes to investment advisor fees, investors are understandably confused.
Not only are there different compensation models to decipher but also, for years, the fee information was less than transparent.
Recent changes to the client relationship model, or CRM2, have added clarity to investment fees and how they’re presented, in dollar terms alongside percentages. However, it’s still up to advisors to help investors understand how they’re being paid for their services and advice.
Advisors need to be proactive in explaining to investors their compensation models, says Keith Costello, president of the Canadian Institute of Financial Planning.
“Nobody want to talk about [fees], but it’s a trust thing with your client,” Mr. Costello says. “You need to explain to your client up front how you are getting compensated … to avoid any conflicts and surprises down the line.”
There are two main types of compensation models that advisors use: commission-based, where their compensation is embedded in investment products and they are paid by the provider through the dealer; and fee-based, where their compensation is based on a flat fee or percentage of assets without embedded commissions. Some compensation models combine the two.
Investors should understand an advisor's compensation model to ensure it’s right for them and their investment goals, Mr. Costello says.
“Your compensation model may not be a fit for the client, for some reason, and they need to understand that,” he says, adding the conversation should address any potential conflicts.
Managing investors’ expectations
There are both moral and strategic arguments for advisors to educate investors on their compensation model, says Moshe Milevsky, a professor of finance at York University’s Schulich School of Business in Toronto.
Morally, he says investors should be told what they pay for services, not unlike when they go to a store or online and purchase any other type of consumer product.
“In the financial services industry, a lot of people have no idea what they are paying,” Dr. Milevsky says, adding that some investors don’t realize they’re paying investment fees at all. “We have to correct that.”
Strategically, Dr. Milevsky says investors are getting more curious and educating themselves about fees online and in conversations with friends and family. Some of that information may be misguided.
“They might actually think you’re getting paid a lot more than you really are. You want to rein in their imagination,” Dr. Milevsky says.
Value for money
Once the compensation model is clearly outlined, many investors will likely see it as good value for the service, says Norm Trainor, president and CEO of the Covenant Group, which provides coaching to financial advisors on how to grow their business.
He recommends advisors be upfront with clients about fees and focus on the value they bring by helping them to meet their financial goals.
“The advisor needs to describe what they’re getting paid for,” Mr. Trainor says. “It’s not just the products, it’s the planning and ongoing execution. For that, there’s a fee.”
He recommends advisors focus less on performance, which cannot be guaranteed, and more on building a longer-term client-advisor relationship – where both sides benefit.
“For most, the right client is someone who values advice and the relationship with the advisor. They are comfortable paying the fee because they see the value. It’s not someone looking for the best price, or to do it on his or her own," Mr. Trainor says.
“The successful advisors are building relationships for life. Their product is the client. Their work is helping the client achieve what’s important in their life. When they do it well, for the client it’s transformational.”