By Rob Carrick The Globe and Mail Report on Business Weekend Saturday, May 14, 2005

Let's be impolite for a moment and talk about the price of investment advice.

With their asset allocation models and their alphas and betas, investment advisers sometimes play the role of the expert who works in a rarefied world where pecuniary concerns are raised only by the rude or ignorant.

Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "The services clients receive include a written investment plan that considers retirement, estate planning, taxes and business issues. Other services include monitoring, periodic reviews and rebalancing to keep your mix of stocks and bonds in line.”

In the real world, no sensible investor engages an adviser without a thorough discussion about fees, just as no one hires a lawyer, accountant or electrician without first talking money. Price may or may not be a deal breaker, but it's certainly essential information when distinguishing one professional from another.

To have a productive conversation with an adviser about fees, you need to know the various options out there and how they compare in price. Consider today's column a quick briefing on this important topic.

With the help of some number-crunching by Adrian Mastracci, a fee-only adviser in Vancouver at KCM Wealth Management, we'll look at three different pricing and advice models and the cost for portfolios of varying sizes. For context, we'll also look at the cost of investing on your own.

FOUR WAYS TO SLICE ADVICE

There are several different ways to do business with an investment adviser, each with different costs. Here, we look at three popular cost examples and contrast them with investing for yourself.

Here are your options.

1. The commissioned adviser who sells mutual funds

Very common and a perfectly acceptable choice for investors with smaller accounts. The adviser may charge you nothing up front to buy funds, or a small commission of 1 to 2 per cent. Another option is a deferred sales charge that only applies if you sell your funds within six or seven years of purchase. As well, advisers receive continuing "trailer fees" from fund companies as compensation for servicing your account over the years.

Investors are sometimes allowed by their commission-based advisers to believe that they pay nothing for advice, which is untrue because trailers are lumped in with the fees that mutual fund companies charge against the gross returns generated by their funds. What's left over is the net return that fund companies report to their unitholders.

Almost all the fees associated with running a mutual fund are combined and then expressed as a percentage of assets to create a measure called the management expense ratio, or MER. The research firm Investor Economics says that if you looked at all adviser-sold funds in all categories and placed the emphasis on the ones with the most assets, the overall MER you'd end up with is 2.47 per cent.

If you do business with a commission-based adviser, then you should know that the gross returns of your funds are reduced by a very rough 2.47 per cent on average, with as much as one percentage point of that going to your adviser and his or her firm.

Here's a chart to show how this would affect accounts of different sizes.

Estimated Annual Fees for an Investor Dealing With a Commissioned Adviser Selling Funds*

* This is a total amount that includes trailer fees paid to advisers and their firms by fund companies. No upfront sales commissions are included here, but if they were they would have the effect of increasing the total cost in the first year.

2. The fee-based adviser

A much more upfront way to do business, but also one that may not be economical for smaller investors. Here, the adviser bills you directly for fees equivalent to a small percentage of the assets in your account.

Mr. Mastracci uses this approach and says the services his clients receive in exchange for their fees include a written investment plan that considers retirement, estate planning, taxes and business issues. Other services include monitoring, periodic reviews and rebalancing to keep your mix of stocks and bonds in line.

Mr. Mastracci says his fees are slightly higher in the first year to cover the cost of the written plan. First-year fees would be as high as 5.4 per cent of assets for someone with a $100,000 registered retirement account (his clients tend to have larger accounts), but they decline to 2.35 per cent if you have $250,000 in a registered account and 1.75 per cent if you have $500,000. In the ensuing years, fees would fall to 3.3 per cent a year for accounts of $100,000, 1.53 per cent or slightly lower for larger accounts.

Note that these rates include the MERs charged by the exchange-traded funds used by Mr. Mastracci to build his portfolios. ETFs are index funds that trade like stocks and their fees are a small fraction of those for mutual funds. If a fee-based adviser were to use traditional mutual funds, he or she would select a special type that strips out trailer fees to prevent the adviser from getting paid twice -- once through the trailer and once through the annual account fee.

Fee-based accounts really come into their own when they're used for non-registered investments. That's because costs related to what the Canada Revenue Agency refers to as "investment counsel fees" are considered to be tax deductible. Mr. Mastracci's calculations clearly show how much lower his clients' fees would be on a net, after-tax basis for non-registered accounts.

Estimated Annual Fees for an Investor Dealing With a Fee-Based Adviser/Year One

Estimated Annual Fees for an Investor Dealing With a Fee-Based Adviser/Year Two and Onward

3. The adviser who sells wrap accounts

Wraps are marketed as a step up from mutual funds, which is a debatable point. Ideally, they offer mixes of stocks and bonds that are precisely tuned to your needs, access to premium money managers, enhanced reporting of your investing results and automatic rebalancing of your holdings. MERs for wraps average about 2.5 per cent for smaller accounts and may decline for wealthier clients. Compensation to the adviser is included in the MER, as with mutual funds.

Wrap fees can be charged directly to the client, as with a fee-based adviser, or they can be embedded in the same way that mutual fund fees are.

In the example below, Mr. Mastracci assumed that the fee was charged directly to the client. In the case of non-registered accounts, he assumed that all but $500 in fees were tax deductible, and that a 40-per-cent tax rate would apply.

One other assumption is that the fees would be 2.5 per cent of assets for accounts of up to $250,000, 2.25 per cent for accounts of $500,000 and 2 per cent for accounts of $1-million.

Estimated Annual Fees for an Investor in a Wrap Account

4. Doing it yourself

If you've got the time, inclination and knowledge, investing on your own can save quite a lot of money. Your stock trades will cost no more than $30 in many cases if you place orders on-line using a discount broker, compared with $80 or more with a full-service broker. Funds can usually be purchased with no upfront commissions, but you'll still have to pay trailer fees to the discounter, while not receiving any advice.

Mr. Mastracci's estimate of the cost of setting up a do-it-yourself portfolio was based on discount brokerage commissions incurred in buying stocks or ETFs, as well as some funds. He estimated the first-year costs at 0.8 per cent of the assets in the account, and the subsequent annual costs at 0.6 per cent.

Estimated Annual Fees for a Do-It-Yourself Investor/Year One

Year Two and Onward

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.