Wednesday, June 11, 2008

THE FEE QUESTION AN ADVISORS DILEMMA


ADVISOR DILEMMA, THE FEE QUESTION

One of the big challenges for an advisor is how to answer the question, what are your fees?

The question is a key one for investors because the way the question is answered tells a lot about how you will be treated as a client!
We have talked in the past about the variety of ways in which fees are charged. I want to state first thing, fees are necessary and you will pay them one way or another. The best of money managers and the worst will all charge fees. The best of course earn the fees they charge and it becomes a win-win situation. But lets get past the fact that fees are a given. Lets talk about how advisors respond to the question.

First Example: In a recent industry magazine I read a letter from an advisor who stated with conviction that his clients did not care for the details on the fees as they were netted from performance which is the bottom line measure for an advisor.

I would challenge that viewpoint by extending the logic to everyday transactions. Assume you were buying a car and wanted to know what you were paying above list price. That tells you how much the dealer is earning on the sale and allows you to decide if it is reasonable. It may not change the price offered, but it provides the buyer with disclosure and an ability to compare dealers. Similarly, if you hired somebody to paint a house you would want to know the cost of the supplies and the cost of labour so you could adjust costs as needed (faster painter or cheaper paint).

Another challenge to the “big picture” defence is the fact that performance numbers are excluded from most statements. If you can’t get pure rates of return or benchmark comparisons then the ability to measure the advisor’s net value is lost. Of course that may be the real intent.

Second Example: Advisor’s often are paid via a combination of up front sales commissions and trailers. Again, let me say that that is not necessarily a bad thing. The commissions are generated from the fund company for the most part and are not disclosed on an individual investor basis. Advisor’s often state that the client is made fully aware of the Management Expense Ratio (MER) on funds purchased, which discloses the fee the client is paying. That is indeed true. It does not however enlighten the client as to how much of the MER is given back to the advisor. That presents a challenge for clients who might explore different options that pay less to the advisor and have lower MER fees if they in fact could make a straight comparison with all facts disclosed. It might be bye bye DSC fees.

Third Example: Many advisors are telling clients that they are charging a flat fee as a percentage of the accounts assets, say for example 1.5%. That is an all cost absorbed fee and is transparent and easy to understand. Finally success you say. Well, not so fast. If these advisors purchase funds or wraps for the client there is often a double payment of the MER and the flat fee. That may not be a real problem when it is clearly explained up front on the fund purchase and an allowance is made to the total fees charged. The problem is when the added MER is quickly shuffled aside in the conversation before the client gets a chance to ask a key question.
If I am paying you 1.5% to manage my account, why am I also paying the fund manager to manage my money as well? If the fund manager is managing the fund, what are you being paid for? Again, disclosure and transparency are the key. A good advisor should be able to justify the fund purchase and should purchase low cost funds and or exclude the asset from the 1.5% flat fee.

So, what do great advisor’s do when asked the question about fees. Well, they actually get out the paper and pencil and go through the various fees they may earn, who is paying them, and why they are being paid, and most important of all how they will report the fees to you. They discuss their role in the process, how they add value, what they commit to on your behalf. You see the best of advisors know that if they treat you like you are the one who is the paying client you will understand how they are helping. They also know that you will not likely switch advisors, because the odds are the new advisor won’t answer the fee question to your satisfaction. The truly great advisors will provide you with full fee disclosure, an annual summary of fees paid, and proper performance results for the funds you are paying to own. They provide a variety of cost options with recommendations as to what is most efficient when you are buying a new security. They discuss the new issue commissions they earn on many products to ensure you understand how your purchase decision impacts their earnings.
It’s not rocket science to make informed decisions with all the relevant facts clearly disclosed to an investor. If a client is “not interested” in the fee discussion then the advisor needs to slow down, back-up, and start the conversation again because clearly they are not conveying the message of how large the fees become over time and how much they can siphon from an account if not properly monitored.
The best portfolios have full disclosure by an honest hard working advisor to an informed and involved client. So does that sound like your situation?
soismike

2 comments:

Anonymous said...

I read this with great interest. Over the years I have used different advisors with about the same results. One question to ask is how many clients do you have and how often do you touch base with them. Then do the math to see how much time he spends with you.
This will tell you how much he charges/hour and if it was worth it.

Mike Macdonald said...

The number of clients is a great question that many investors get wrong. Having 300 clients is not a positive.....and neither is having 30 clients. I do not want to be ignored, but I also do not want to be the cash flow for a new advisor.