The reason why knowing what you are pay in fees for your investment portfolio is important is because the return of your portfolio will be what you make less what you pay. The higher the fees, the lower your return.
Background
The investment industry is quite complex in terms of fees. The government is asking investment providers to disclose their fees to investors. This is a good first step. However, in my experience many investment professionals are not even aware of many of the hidden fees or fees that are not collected by them.
Let’s consider a brokerage account at a bank. The broker may charge 1% to manage the account for you. Within the account there may more fees. For example, bank product with “no” fees like GICs, as well as mutual funds with their own embedded management fees and then stocks and bonds that the broker purchases that may have incurred brokerage fees depending on how the account is set up regarding fees. This is a messy example to give some perspective how complicated it can be.
And if you ask the broker what the fees are, the broker may say 1% as that is the fee paid to the broker. However, in this example, the fees paid by the investor are more.
Example
Let’s assume the investor has $100,000 in a managed brokerage account. For example:
$25,000 invested in stocks
$25,000 invested in GICs
$25,000 in bonds
$25,000 in mutual funds
The broker may charge 1% on the full value to pay for their service. This is $1,000 per year.1
For the stocks, a brokerage trading fee would be charged and would be embedded in the book value/purchase price of the stocks. Let’s assume for illustration that this is about 1% once when you buy the stock and then when another 1% when you sell the stock in future. Thus for year one, you have paid $250 in brokerage trading expense.2
GICs typically have an embedded margin/fee in the rate you receive. For example, the bank offering the GIC makes 3% on the money and pays you 2% – thus the embedded margin is 1% – thus for this example, the embedded margin is $250.3
When a broker buys a bond, there is no brokerage fee however, the price you pay for the bond is the “retail” price which is higher than what a professional bond manager would pay due to their “institutional” status. This price difference can be between 1-5% more depending the bond and how much you purchase. In this example, let’s assume 3% is the price differential.4
Lastly the mutual funds have embedded management fees and expenses which are often referred to as the fund’s “MER”. The average MER in Canada is 2.50%. I have seen them as high as 4% when you read the small print – literally. However, let’s assume 2.5% for this example. Thus the MER for mutual funds is 2.5% * $25,000 = $625.
Therefore the total fees are, in my opinion:
Broker’s management fee = $1,000
Stock brokerage fee = $250
GIC embedded margin = $250
Bond embedded margin = $750
Mutual Fund MERs = $625
For a total fee of $2,875. Based on a portfolio value of $100,000, this represents a fee of 2.875% in the first year.
In the second year if the stocks and bonds are held and not sold, the annual fee would be $1,000 less or $1,875 which is 1.875% for the second year and the following years until bonds and/stocks are sold.
Summary
The moral of the story is what you believe you are paying may not be the full story. Therefore ask your investment provider to provide you with ALL the fees you are paying.
There is nothing wrong with paying for services. You simply need to know what you are paying, ensure you understand it and ensure you believe it is fair and the best you can do.
Click here for a spreadsheet that may help you determine the fees you are being charge. There is an example sheet and then a sheet for you and/or your investment advisor to complete.
1 1% * $100,000
2 usually charged by a flat fee plus cents per share – in this example I have assumed 1% * $25,000
3 1% * $25,000
4 Thus the embedded margin/fee is 3% * $25,000 = $750
