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The very first question that every prospective client I've ever met with has asked me is "how do you get paid"? I tell them I'm compensated in one of two ways: I can give you advice and guide you through all facets of your financial plan, with no commissions charged to invest your money. In this case I would invoice the client for my time, at my hourly rate, like any other professional would. OR I can provide the same services without invoicing for my time, in which case I'd be compensated from the commissions generated from investing their money. Given that the "financial" part of financial planning inevitably involves the investing of client's money. Typically, when the new investor meets a financial planner for the first time, they're very concerned about having to pay fees. These people have been dealing with the banks up to this point, and haven't had to worry about fees; since bank mutual funds are "no-load". At some point though, they've realized that they need help beyond what the bank employee is capable of providing. That’s usually when they come to see me. The mutual funds I sell differ from the banks in that they are "LOAD" funds. So in this column I'm going to examine the investment product that makes up about 80% of my clients investments, Mutual Funds.
The first thing I'll do is explain what a mutual fund is, in case anyone doesn’t know. A mutual fund is an investment vehicle where many investors put money into a collective "fund". A professional fund manager then actively buys and sells investments with the money in the fund on behalf of the investors, in accordance with the stated objectives of the particular fund. Each investor receives UNITS in the fund based upon the proportionate amount of money they put into the fund. All assets of the mutual fund are re-valued at the end of every day, and then divided by the number of UNITS outstanding. This gives us the value of the fund "per UNIT". The initial value of your mutual fund Units are determined at the end of the day on which you put your money into the fund. There are many different types of mutual funds. If the fund were categorized as a "BOND" fund; then the manager would select only bonds to put into the fund. If the fund were categorized as an "equity or stock" fund, then the manager would select equities to put into the fund. Some funds are categorized as "Balanced or Asset Allocation" funds. In this case the manager would select a mix of assets, (stocks, bonds, and cash) based upon their knowledge as to which way they felt the value of each were heading. Mutual funds can be further segmented by countries and/or regions (i.e. Canada, US, Europe, etc.), as well as sectors of the economy (Health care, banking, technology, etc.). The funds manager charges the funds investor's, an annual management fee. This is a pre-set percentage of the total market value of the assets of the fund, at year-end. This amount is taken out of the fund, right off the top, at the end of each year. Regardless of whether the fund went up or down in value. EVERY mutual fund charges a management fee; even if they're a no-load fund. The average stock mutual fund in Canada has a management fee of 2.5%; the average bond fund fee is 1.75%. What you're essentially doing when you buy into a mutual fund is your sub-contracting out to the funds manager, the selection of your investments. The manager is also deciding when to buy and sell these assets, on your behalf. The mutual fund industry in Canada (as well as the U.S.) has three different types of LOAD options for the purchasing of mutual fund's. There's "BACK END" load, "FRONT END" load, and "NO-LOAD". Let's start with NO-LOAD. All major banks in Canada, as well as Altamira and a few others, offer a wide variety of mutual funds to the public, that are considered NO-LOAD. What this means is, you can buy into these mutual funds at any time, and you won't be charged any up-front commissions or fees. As well, if you decide to sell all of your units in the mutual fund, one-day, one-week, one-month, one year later, and take out all of your money from that fund; you won't be charged any fees or commissions at that point either. Some banks may charge an account-closing fee, but beyond that, there are no "LOADS". Without commenting on the quality of the management of these no-load funds. The banks and Altamira generally do not provide face-to-face financial advisory service's to the mutual fund investor, BEYOND the purchasing and selling function. Now let's take a look at the other two types of funds that most independent financial advisers sell. There are now over 100 different independent mutual fund companies in Canada that offer over 10,000 different mutual funds; and that’s not including the Life Insurance companies. When you consider the first mutual fund was offered for sale in Canada on November 29, 1954; you can see how selecting a fund can be a little overwhelming. Thus, from this has emerged the broker/investment adviser/financial planner, etc. to supposedly explain all the differences, and market these funds to the public. FRONT-LOAD: Front load means the investor pays an up-front commission when they put their money into the fund, and purchase units of the fund. For example: If an investor were buying $1000 worth of a mutual fund that had a unit price on that particular day of $1; and the adviser and investor agreed to buy the fund with a 2% FRONT-LOAD charge. Then the investor would pay the dealer $20, and the remaining $980 would go into the mutual fund. The investor would then receive 980 units of the mutual fund. If the investor chose to sell all their units in the mutual fund, and take out their money from the Fund Company; they could do so with no fees or commissions. The front load fee (%) is negotiable with the adviser. In addition to this up-front commission; the mutual fund companies pay the dealer a 1% annual service fee, for the mutual funds that were sold to their investors "FRONT-LOAD". This 1% service fee, (which is known in the industry as a "trailer fee") is paid out based on the MARKET value of the investor's mutual fund units. So if the investors units go up in value, the adviser gets paid more. BACK-LOAD: Back load means that the investor pays nothing up front when they put their money into the mutual fund. If they put in $1000, and the unit price was $1, they would get 1000 units in the mutual fund. However, if the investor chooses to sell all their units in the fund and take their money out of the particular Fund Company; they'd pay a declining exit fee or "BACK-LOAD" to leave that Fund Company. If the investor sells their units in one particular mutual fund, and goes into another fund WITHIN that same fund company, then there would be no charges or fees. The declining BACK-LOAD schedules are different with every fund company but generally they work something like this: If you leave the fund company within the first year (within12 months of purchase), you'll be charged 6% of the closing market value of the units that you're cashing in. In the second year it drops to 5%, 3rd year 4%, 4th year 3%, 5th year 2%, 6th year 1% After 6 years from the date you put the money into that particular mutual fund company, you can haul the whole thing out, whatever its worth, with no fees. The dealer receives a 5% commission, of the invested amount, from the fund company, on a back-load sale. The mutual fund companies pay the dealer's, 0.5% annual service (trailer) fee on fund assets sold BACK-LOAD, as opposed to the 1% paid on front load. Another feature of BACK-LOAD is the Fund Company allows you to take out 10% of the units of your mutual fund every year, with no fee. This 10% commission free amount works on a calendar year basis, not on an anniversary year basis like the back-load schedule. So you could put $1000 into a fund back-load on December 27TH, and take out $100 the next day, with no fees. Then a week later on January 3rd of the next year, take out another $100, also with no fees. Some fund companies allow the investor to accumulate the free 10% year-over-year if they don’t use it, (i.e. I didn’t take out 10% last year, so I can take 20% this year); but most don’t. Most of my clients are investing in mutual funds for the long term. They don't anticipate needing their money within the next six years, so obviously they'd rather not pay anything. As a result, the selling of back-load mutual funds derives the majority of my financial planning income. Knowing what I know if I were an investor who was considering hiring a financial planner, the first question I'd ask is "what will I get, in terms of service, from a financial planner, that I wont get at the bank"? I mean if I'm going to move my money from investments that don’t charge ANY fees, over to investments that could potentially cost me a lot of fees; "what's in it for me"? I can't speak for other planners and brokers, but as a Certified General Accountant with over 15 years of public practice experience, I offer clients who agree to invest their money with me, my tax and accounting expertise, for free. This offer is my "loss-leader". It costs me time and effort to do peoples tax returns, financial statements, etc., but I'm compensated from the commissions generated by investing the client's money. Other ways of providing service to clients are; designing long-term retirement plans and regularly monitoring and updating them; dealing with other professionals on your behalf, (i.e. the bankers, lawyers, etc.) and giving advice, to name a few. I'd suggest that if your not receiving something of value from your planner/broker, in exchange for investing your money with them, then it might not be worth leaving the NO-LOAD side. NO-LOAD is synonymous with "NO-SERVICE". If you're not getting any service from your planner/broker, etc., what's the point? The next investment vehicles that I'll look at are "Index Funds". Most people have heard of the TSE 300 composite INDEX. It's a numeric indicator that tracks the movement of the value of the stocks of the top 300 companies listed on the Toronto Stock Exchange. If the average value of these 300 companies goes up, the TSE 300 index goes up. A TSE300 INDEX fund allows the investor to put their money into an investment that will mirror the movement of the TSE 300 index. There's no fund manager in an index fund, because there's no decision making involved in WHAT to put into the fund. The fund will always have the same stocks of the same top 300 companies listed on the TSE. If a company goes bust or gets too small, and ends up being removed from the TSE300 index (Bre-X); then the index fund would remove that companies stock as well. So how does this differ from a regular mutual fund? The key difference is a manager doesn't ACTIVELY MANAGE the index fund's assets. The other difference is index funds have an average annual management fee of 0.5%, as opposed to the 2.5% for the average equity mutual fund. My opinion on index funds; when the markets are going up, they can be a much cheaper alternative to actively managed mutual funds. However, when the stock & bond markets are getting slaughtered like they did in 2001, actively managed mutual funds are a much better place to be. Example: The TSE 300 index lost 14% in 2001, so the TSE index fund also lost 14%. The Trimark Canadian Fund, an actively managed Canadian stock fund, had a +4.6% return for 2001. The last investment vehicles that I'm going to look at are "ETF's" or Exchange Traded Funds. These are like the index fund except these are traded as an actual stock listed on a stock exchange. Thus, the investor would buy shares in an ETF directly from the exchange it's listed on. Example of an ETF would be the "spider". The spider is listed on the New York stock exchange and its stock ticker symbol is "spdr". The spider holds all of the stocks of the 500 companies that make up the S&P 500 index. The S&P 500 index is a numeric indicator that tracks the stocks of the top 500 companies in the U.S. Another difference between ETF's and index funds is the management fee. ETF's are even lower then index funds, averaging around 0.2%. ETF's also come in all sorts of different types like ETF's that track just bank stocks, technology stocks, gold mining stocks; or stocks of companies from certain regions i.e. Europe, Japan, etc. All of the investments I've spoken of have one thing in common; they're all diversified portfolio type investments. The key word here is diversified. If this past year has taught us anything it's that as an investor, you must be diversified!!!! Many mutual funds held the stock of Enron in their portfolio when the company went bust last summer. However, unlike those people who had their life savings in Enron stock, the mutual fund owner's weren’t wiped out by it. In fact a lot of the actively managed mutual fund managers, sold off all of their Enron stock, before the collapse. Unlike index funds, which would have held Enron right up to the bitter end, since it was still part of the Dow and the S&P, on the day the company filed for chapter 11. |
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