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Inside the Market Understanding a crucial yet mysterious fee investors pay their advisers

Look to the trailing commission you pay if you want to grade the value you’re getting from an investment adviser who sells mutual funds.

It’s easier said than done, though. A reader was recently studying his annual investment fee disclosure statement and tripped over trailing commissions. “I didn’t actually pay those fees, yet they must have an adverse effect on my returns,” he said.

Actually, this person is paying trailing commissions. And, yes, they do have an adverse effect on returns. Trailers are how many advisers get paid for managing client mutual fund accounts. Let’s say the management expense ratio for a Canadian equity fund is 2.25 per cent. Typically, 1 percentage point of the MER would be accounted for by the trailer. Fund companies deduct the MER from gross fund returns, and direct the trailer component to advisers and their firms to share. Returns reported to investors are always shown on an after-fee basis. Trailers are not paid directly by the investor.

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As a big factor in fund MERs, trailing commission obviously undercut fund returns. But it’s overly simplistic to blast trailers on that basis alone. A better approach is to look at the value provided by an adviser who receives trailers. Some ways an adviser can earn his or her trailer:

  • probing to find out how risk tolerant you really are
  • building a sensibly diversified portfolio and rebalancing it as required
  • meeting with you once per year to discuss progress made toward reaching your financial goals and to see if your personal situation has changed.
  • offering reassurance when stocks plunge
  • providing recommendations for best in class investments and not just in-house products
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