Financial Advice - Are you Getting What you Pay For?

I was pretty surprised to read about a rather dramatic change to the financial planning profession in Australia.  Financial planners certified under the Financial Planning Association (FPA), will have to abandon the practice of receiving trailing commissions from investment products if they want to remain members. The organization has asked their members to go to a "fee-for-service" model which means that certified financial planners will only be able to receive payment directly from their clients instead of accepting commissions from product providers, such as mutual fund companies.

Will this happen in Canada? Probably not anytime soon. The Financial Planners Standards Council, the Canadian counterpart to Australia's FPA, currently doesn't take a position on how financial advisors are paid other than requiring that financial planners fully disclosure the way they are being compensated to their clients. Barring a major scandal such as the one that triggered these reforms in Australia, there is unlikely to be an immediate call for major changes here in Canada. But this doesn't mean that investors shouldn't be looking very carefully at the compensation issue here.

Under the current system in Canada, even if the compensation model is disclosed, it's often only done so by way of a prospectus. Financial advisors selling funds are required by law to provide investors with a prospectus, but let's be honest - they are notoriously hard to understand and seldom read. Often there is no open and meaningful discussion of fees between client and advisor and details are often glossed over.  The bottom line is that even if the industry is doing what it needs to do to fully comply with the law -- most people really don't understand what fees they are actually paying.

Having worked under the mutual fund commission model in the past, I'm not a fan of mutual fund companies paying planners to provide advice to clients.  It muddies the waters and it's a complicated system that isn't easy to explain to clients. Not to mention that the commission-based system can -- overtly or subtly -- affect a financial planner's recommendations - even those who are scrupulously ethical and honest. I know, I was there.

So how do you know if you are getting value from your financial planner?  Start by finding out how your advisor is being paid and what fees you are actually being charged. This isn't always as easy as it sounds, but you can either ask your planner directly or check your mutual fund prospectus. 

To give you an idea of how mutual fund compensation works, here's a typical scenario (actual fees will depend on the mix of funds you are invested in):

If you invest in mutual funds distributed through a financial advisor (usually referred to as "load" mutual funds), and you have a portfolio of $200,000 with a mix of stock and bond mutual funds, you're probably paying an annual management fee of around 2%. This means that, every year, you are paying $4,000 to have your investments managed.  Roughly speaking, between 0.5%  and 1% of this fee (or $1,000-$2,000 per year) goes to compensate your planner for providing you with service and advice. The rest of the fee goes to the mutual fund company to pay for investment research and selection, administration, marketing, etc. 

You then need to ask yourself - am I getting $1,000-$2,000 worth of financial planning and investment advice every year directly from my advisor? Using an hourly rate of $200 (a typical rate for an independent fee-only financial planner), this means you should be getting between 5 and 10 hours of your planner's time and attention.  If you are, then you're likely getting a good deal, if not, well, maybe it's time for a serious heart to heart chat with your planner. - Karin Mizgala

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