Are Hidden Fees Sinking Your Investments?

It’s common knowledge that you get what you pay for, and it just makes sense that consumers should always know exactly what they’re buying and how much it will cost them. But when it comes to understanding how their investments are doing and how much they’re paying for financial advice, many Canadians are in the dark.

It’s not that these investors are ignorant or unsophisticated. The real problem is an entrenched lack of fee transparency in the financial services industry that makes it impossible for most investors to figure out how their investments are doing, how much they’re paying in fees, and what those fees actually cover. And this lack of clarity could be putting the financial well-being of some investors in jeopardy.

Investors assume their financial advisors are working on their behalf and looking out for their best interests. In fact, the vast majority of advisors work within a system that frequently puts their financial interests at loggerheads with their clients’ long-term goals.

Most advisors work on commission. For example, an advisor invests his client’s money in Fund A. Fund A then pays the advisor a commission that is deducted from the investor’s overall return. Certain types of investments, such as equity funds, trigger higher commissions than fixed income investments such as bonds or mortgages. This means the advisor has a vested interest in recommending certain classes of investments over others. What’s more, because the commission-based advisor is being paid, in effect, to sell mutual funds, there is little incentive to recommend commission-free investments or to provide comprehensive advice in areas such as tax and estate planning.

I’m not opposed to the commission-based model, provided investors know exactly what fees they are paying, and what they’re for. But in recent years, the investment industry has come under attack from media and regulators on account of its failure to provide investors with clear and concise reporting on fees and returns. Examples include monthly or quarterly financial statements that show investors’ total holdings, from which trailer fees and commissions have already been deducted, but do not show rates of return or how much was paid in fees. This is a huge problem for investors as they deposit and withdraw funds from their portfolio.

The Canadian Securities Administrators, the association representing provincial and territorial regulators, has made several recommendations to the mutual fund industry, including full disclosure of all compensation, removal of trailer-based compensation, and regular reporting to investors of their returns on all funds after all costs have been deducted.

Last year the Canadian Securities Commission, a discussion forum soliciting recommendations, published a discussion paper that called for increased transparency from the financial services industry. Regulators need to transform this call to action into new regulations that mandate clear, detailed and transparent reporting.

Investors need to demand greater transparency from their advisors. A great start is to ask your advisor the following questions: How are you compensated? What are your total fees? Are there any third-party costs? Do your quarterly reports include commissions and fees? What planning advice will you provide, and is this advice included in your overall fees? Advisors who don’t answer these questions to your satisfaction, or won’t answer these questions, should be passed over for advisors who will.

Rather than waiting months or years for new regulations to take effect, advisors can begin offering more transparent fee and investment portfolio reporting today. A few Canadian advisors (fewer than 20 per cent) have already moved to a fee-based compensation and transparent reporting model, under which investors understand exactly how much they are paying for financial advice, and how well their investments are doing. Other firms should follow suit.

Only when the industry as a whole adopts more transparent compensation and reporting models will Canadian investors have the information they need to determine whether the price they’re paying for financial advice is truly worth it.