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Fees, Fees, Fees

Just when you think you've found them all, another one appears. And they all eat into your returns.

Odds are good that you're woefully ignorant about the subject of investing commissions and fees, but let's not rush to judgment. First, try a quick exercise where you list the annual management expense ratios (MER) on any mutual funds you own. Then, write down the other fees and commissions you pay your broker or financial adviser. If you even came close to supplying the right numbers, congratulations. "Maybe one in four investors have some sense of the management expense ratio, and I might be generous when I say that," says Dan Richards, principal at Strategic Imperatives, a Toronto consulting firm that works with fund companies and investment advisers.

Fees and commissions are often invisible unless you know where to look. Why make the effort? Often, the less you pay, the bigger your return will be. Of course, you get advice and services for those fees and commissions. If you know what you're paying, you can tell if you're receiving good value. There are two types of fees and commissions: those incurred when you buy or sell investments, and those that apply to investment advice. Commissions on stock trades are straightforward and don't need review here. Mutual funds are more complicated. There can be charges to buy and to sell them, plus yearly fees for owning them.

Let's use the Templeton Growth Fund as an example. It is one of Canada's oldest mutual funds, and the largest by assets at around $9.4 billion. If you buy the popular A version of the fund through an adviser or broker, you have two options. You can pay an up-front sales commission, or front load, of up to 6%, although 2% to 3% is more typical. If you want to avoid an up-front fee, you can choose the deferred sales charge (DSC) option. You'll pay a redemption fee if you sell fund units and do not switch the proceeds to another Templeton fund. The fee begins at 6% if you sell in the first year you own the fund, and declines to zero in steps over the next six years. If, for example, you want to sell your Templeton Growth units in the fourth year, the redemption fee would be 4.5%.

Roughly 70% of funds sold by independent advisers use the DSC option, says Richards. Most clients prefer to pay later-or not at all, if they hold the fund long enough. The adviser has a strong incentive to sell the DSC option. With Templeton Growth, the fund company, Franklin Templeton Investments Corp., pays the adviser a 5% commission right away. That's higher than the 2% to 3% an adviser might make from a front-load fund. That is not the only fee the adviser gets, either. To cover the cost of providing you with continuing advice and service, fund companies pay so-called trailer commissions. If you bought Templeton Growth on a front-load basis, Franklin Templeton would pay your adviser trailer commissions that are usually equal to 1% of your investments annually. The DSC version of the fund would pay 0.5% annually.

Remember, trailers are paid to whoever sells you a fund-even an on-line broker. This is controversial because on-line brokers provide no ongoing service, other than statements and record-keeping. Also, these commissions are not an item on your fund statements.

There is also a small minority of advisers who use a "zero-load" model-selling load mutual funds with no front or deferred charges, and relying on trailer commissions for income. Established advisers with many clients tend to do this. Novices rely more on up-front commissions from DSC funds.

All right, you've bought Templeton Growth. Now, say you've owned the fund for a year and it's made a posted return of 10%. Really, the fund made closer to 12.2%. How's that? A portion of the fund's returns every year pay for expenses, such as the fund manager's salary, trailer commissions, marketing charges and so on. These costs are measured through the MER-the expenses incurred by a fund expressed as a percentage of total assets. Templeton Growth's MER is 2.21%. Expenses are deducted before fund returns are calculated.

A low MER is a definite asset in helping a fund achieve higher returns in the long run, so be highly skeptical of funds with bloated annual fees. In the case of Templeton Growth, you could argue that the MER is a good value. It is below average for global equity funds. Also, the fund's returns beat the average for its peer group by a whopping 2.6 percentage points over the 10 years to Feb. 28.

Most financial advisers and brokers make a living off commissions made from the buying and selling of funds, stocks and bonds. The cost of the adviser's time for providing investment advice is included in these commissions. An alternative is to charge clients directly for advice, and a hot trend is something called a fee-based account. Here, you pay a fee equivalent to a set percentage of the assets in your account each year, typically 1% to 2%.

The Toronto-based research firm Investor Economics Inc. says fee-based assets are the fastest-growing category in the full-service brokerage world, accounting for 34% of invested assets as of last Dec. 31, or a total of $138 billion. These accounts usually include the cost of all securities trades as well as advice. Because your adviser earns a steady annual fee, he or she has no incentive to propose that you trade simply to generate activity, or to suggest DSC funds just because of their big up-front commissions.

The downside of fee-based accounts is that some clients may end up with higher fees than in a traditional account. If you pay 1.5% annually in a fee-based account that holds a mutual fund with an MER of 1.5% (there are special low-MER funds for fee-based brokerage accounts at major investment dealers), then your total annual cost for holding that fund would be 3%. That's too high. Fee-based accounts at major brokerage houses are available to clients with as little as $100,000 in their portfolios. The fees start at about 2%, and decline to 1% for larger accounts.

A much less common option is the fee-only model, where the adviser charges a set amount for services that might include a detailed financial plan, but receives no commissions on the sale of investments. Few advisers work this way, and they tend to specialize in high-net-worth clients. Warren Baldwin, a financial planner at T.E. Financial Consultants Ltd. in Toronto, says his firm has a minimum fee of $1,500, but charges $4,000 to $5,000 for a comprehensive financial plan that covers retirement, tax and estate planning issues. These fees are typical of what you'd pay elsewhere.

If it feels awkward to raise the issue of fees, just remember that the benefits of the conversation can translate into higher returns. Also, good advisers expect their clients to ask. "I am never under any illusion that clients are going to look at the amount they owe and blithely write a cheque," says Baldwin. "In the back of everyone's mind is a little cost-benefit calculator."


Suppose you buy a mutual fund early in the year. You face three fee options:

paying an up-front commission (front load), paying a deferred sales charge if

and when you leave the fund, or negotiating a zero-load. Here's how each option would work for a $10,000 investment, assuming a 10% average annual return.

1) Front Load

Up-front commission $200 (2%)*

Redemption fee 0

Value of your holdings if you cash out near the end of the 4th year $14,348

Your adviser and his or her firm make...

Up-front 2%; Trailing commissions 1% per year

** up-front commissions are negotiable

2) Deferred Sales Charge

Up-front commission 0

Redemption fee declines from 6% to 0 over six years

Value of your holdings if you cash out near the end of the 4th year* $14,048

Your adviser and his or her firm make...

Up-front 5% paid by the fund company; Trailing commissions 0.5% per year

*redemption fee is 4.5% of the value of 90% of your holdings (you can redeem 10% free)

3) Zero-Load

Up-front commission 0

Redemption fee 0

Value of your holdings if you cash out near the end of the 4th year $14,641

Your adviser and his or her firm make...

Up-front 0%; Trailing commissions 1% per year

© 2007 The Globe and Mail. All rights reserved.

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