Q&A: Fee-based accounts
Question: I have been thinking about switching financial advisors and am looking at one that is fee-based. I like the fact that this may better align the objectives of the adviser with ours, as the firm’s revenues are directly tied to how much money they manage and not to sales commissions. The part that I am struggling with is comparing the fees to those of a conventional broker. I suspect that there are lots of hidden fees with the latter and that unless I ask the right questions of my broker I am not confident that I will get a complete picture. Could you make any generalizations about the cost of the two compensation systems?
Also could you outline the areas that I may be paying fees so that I can ask intelligent questions of my current broker? The only areas that I am aware of are MERs, sales commissions on mutual funds, and broker commissions for equity trades. I’ll bet that the list is far longer as we hold a number of other types of investments (REITs, premium and discount bonds, high-interest cash accounts, ETFs, etc). – Matthew R.
Gordon Pape answers: For starters, I agree that a fee-based account removes much of the conflict-of-interest potential in the broker/client relationship, especially when it comes to mutual funds. If you have a fee-based account, you are permitted to purchase F units of the funds of your choice. Since these units do not pay trailer fees to advisors, there is no financial incentive to recommend one type of fund over another (e.g. equity over fixed income).
You have correctly identified most of the major costs associated with a brokerage account. The major one you missed is commissions on bond trades which are hidden in the price you pay. In fee-based accounts, no bond commissions are charged — you pay the same price as an institutional buyer.
There can be other expenses in a brokerage account such as interest on margin loans, etc. but these are more specialized. All brokerage firms must publish a list of their charges — just ask for it.
The cost of a fee-based account is negotiable with the advisor but it will typically run between 1% and 1.5%. I have heard of complex accounts being charged as much as 1.75% because of the extra work involved. If you are quoted a rate under 1% it may be because the advisor is offering a low-ball price to build his or her book. Ask how long the rate is guaranteed for.
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