Fees - Part Four: Fee-Based Accounts

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In response to the concerns expressed by investors regarding the traditional model, the Fee-Based Model was introduced. This model has the benefit of putting advisors “on the same side of the table” as their clients. This is because clients are not charged on a “per transaction” basis, but instead clients pay a fee for the management of their accounts. This fee is based on the total assets you have with an advisor, and the fee percentage typically gets smaller the more money you have with that advisor.

 

 

To get your head wrapped around how this is different from a trailer fee on mutual funds… it isn’t.

 

The trailer that is paid to compensate advisors for their work is the same sort of idea when it comes to fee-based accounts. Your advisor is encouraged to ensure that your money is growing, as they get paid more when your account increases in value. A win-win and it keeps your advisor on the same side of the table as you.

 

There are two main differences between Trailers and Fee-Based:

  1. In Fee-Based accounts, you are able to deduct the fees that you pay your advisor. This only applies for non-registered accounts (otherwise known as “Cash” accounts), but can make a large difference in the effective fee you pay. I will demonstrate this concept in a chart below.
  2. Fee-based accounts can hold any asset type. This can include stocks, bonds, Electronically Traded Funds (ETFs), Guaranteed Investment Certificates (GICs) and mutual funds. This means that rather than pay a non-tax-deductible trailer fee, you could instead compensate your advisor in a way that is tax-deductible for you. If you this is an important consideration and something that we would be happy to discuss with you. For more information give us a call at (403) 220-9808 or via email on our contact page.

While this all good and fine, I am sure that you are wondering what the fee structure looks like and thinking “how much would I pay?”

 

The fee-based model has many different forms depending on the institution you work with, but typically advisors have 3 different models that they can choose from.

 

The first model is a flat percentage (%) rate.

 

This means that regardless of the type of investments you have in your account, you would pay a flat fee as a percentage of the total assets you have in your account. For an example: if your total assets you had with an advisor totaled $1,000,000 your fee might be 1% of the assets in your account. If that was the case, you would pay $10,000 per year for the management of your account. This would be the case if the value of your account did not change over the year. I say this because the fee is typically calculated daily and charged monthly. If your account dropped to $900,000 in a given month, your fee for that month would decrease from $833.33 ($10,000/12) to $750 ($9,000/12) for the month. This means that, once again, your advisor is encouraged to ensure your accounts value increases. The main drawback with this model is that some of your investments will return more (historically than others). The following hypothetical chart helps to capture a few concepts including the tax-savings you could experience (see disclaimer):

 

 

As you can see, this model of fee-based accounts does not take into account different asset classes. Why should you care? Because as of publishing this document, GICs are paying 1.51% for a 1 year time period. This means that if you were on this model, your GICs would be effectively paying you 0.51% after taxes. Not a great deal. Of course, if you are only holding one type of investments (let’s say stocks for simplicity sake) you would be getting a good deal. If you were holding historically lower-returning assets (bonds, GICs, or Cash) you would not be getting a good deal.

 

You can also see the impact that being able to deduct fees you pay in non-registered accounts can have. As with any tax strategy it is important you discuss any tax-related ideas with your accountant before exploring this idea with any advisor.

 

The second model is a flat dollar ($) fee.

 

Much like the first model, this model does not take into account different types of assets. However, if your account does very well, you would be getting a great deal in comparison to the flat percentage model. Why? Because if your account, as in the example above, grew to $1,500,000 you would be paying $833.33 ($10,000/12) instead of $1,250 ($15,000/12) per month. On the other hand, if the value of your account dropped to $700,000 you would still be paying $833.33 instead of $583.33 ($7,000/12). Ultimately, the negotiation between you and your advisor will decide what the fees look like, but keep in mind, every institution has a minimum fee that they require advisors to charge for fee-based accounts. Have a look at this hypothetical chart, which looks quite similar to the flat percentage chart (see disclaimer):

 

 

Finally, the model that we believe in is the Customized fee for each Asset Class.

 

We believe in treating each of our clients fairly and believe that the best way to do this is to base a fee on the types of assets our clients hold. This means that we charge less for assets which historically have not generated high rates of return and charge a fair price for those that have. To understand the concept a little easier, let’s have a look at this hypothetical chart (see disclaimer):

 

 

As you can see, holding the same assets under this model is significantly cheaper than the other two models.

 

Everyone’s portfolio needs to be constructed differently. We work with each of our clients to determine what risk they need to take on in order to achieve their short and long term goals. All of this stems from the quality financial plan we create with them. We feel that this model is most applicable and fair to our clients as we continue to work hard to see their money grow and to not unnecessarily decrease return on assets which are designed to be safer.

 

We hope that this has been an informative series. If you have questions about this or any other topic, be sure to fill in the form at the bottom of the “Thinking Out Loud” page, give us a call or send us an email.