This blog is a continuation of our Precision Financial Mini Series on investment fees.
As an investor, it is important that you understand what sales charges and investment fees you will pay once you and your financial advisor or financial planner agree upon an investment plan. In our previous blog, we spoke about a recurring annual fee called a Management Expense Ratio (MER). In this blog, we focus on sales charges.
Simply put, sales charges are paid when you purchase an investment (in these examples, we are referring to mutual funds, segregated funds, securities and stocks; however, this is not an exhaustive list). Unlike the MER, a sales charge is a one-time charge during the purchase process. It is worth noting that sales charges are not always paid, and your financial advisor or financial planner may waive the sales charge altogether. In that respect, it is worth asking your advisor what sales charges you will be paying.
Sales charges are paid differently depending on the type of charge and the underlying investment. Below, we provide general comments on common types of sales charges.
Front End Load (or No Load)
A front end sales charge is calculated as a percentage of your principal and deducted from the principal amount of your investment. As an example, if you have $10,000 to invest and the front end load charge is 3%, $300 is paid directly to the advisor’s investment dealer. This means the amount invested will be $9,700 ($10,000 less the $300 sales charge). Financial planners and financial advisors may also set the front end charge rate at 0%, meaning they take nothing as an up-front payment, and the full principal is invested.
A low load sales charge is calculated differently than the front end sales charge. Ultimately, no money is deducted from the principal amount of your investment. The full $10,000 from our example above is invested. The fund manager pays a sales fee directly to your financial advisor’s investment dealer.
There’s a catch to this. You must keep your money in the fund for a specified period, typically on a declining redemption scale, or “fee free” period. A declining redemption scale reduces the early redemption fee every year until it is zero. If you transfer your money to another financial advisor or financial planner before the early redemption scale is done, the fund company will withhold the sales charge previously paid to the financial advisor on redemption. You do not receive the full $10,000 back, you receive $10,000 minus a percentage of the original sales charge. In other words, you are responsible for reimbursing the fund company for the sales charge previously paid to your financial advisor.
Key Question: If you know you are paying a low load fee, ask how long your money needs to stay in the fund until you can move it without incurring a fee.
Deferred Sales Charge (DSC)
A deferred sales charge operates like the low load charges described above; however, they are paid at a higher rate and you have a longer declining redemption scale (or “fee free” period). Your principal is fully invested, and a sales charge is paid to your financial advisor’s dealer.
Once again, you are locked into repaying the sales charge to the fund company if you move your money prior to the end of the fee free period.
DSC charges are harmless if you intend to keep your money invested at the same institution long-term. However, if you are feeling uncertainty about the long-term use of your funds, you will want to avoid these charges. As noted, the sales charge is higher than low load and the redemption scale is longer. These days, many advisors opt to use low load or no load rather than DSC charges.
Key Question: If you are unsure how long you want to leave your money in a fund, ask if you can opt for a low load sales charge instead of a DSC, since a DSC uses a higher up-front percentage and the redemption scale is longer.
Investors with a larger net worth may have a fully managed stock portfolio with a registered stock broker. The broker will buy and sell (in other words, trade) the stocks on the investor’s behalf to maximize returns. There is a fee charged for each trade, so the more your stocks are traded, the higher you will pay in fees. In some cases there are also annual charges to maintain the account itself, including custodial fees. The fee is charged because there is administrative work associated with buying and selling each stock.
Fee for Service Charges
Fee for service is exactly as it sounds: a financial advisor or financial planner charges a fee to recognize the services provided to you. This can be an hourly fee (for example, paid for putting together a financial plan) or an annual fee, designed to compensate for time spent reviewing your financial portfolio.
A fee paid for a financial plan is designed to compensate the financial advisor for the time they spend analyzing your information to design a plan tailored to your needs. If you think this sounds presumptuous, remember that a lawyer or accountant will charge an hourly fee to provide advice, and the time spent by a financial planner providing advice to you is really no different.
Key Question: To avoid being blindsided by unexpected fees, ask upfront if your financial planner charges an hourly or annual rate for their services and how this is structured, particularly if you end up investing with them.
Every financial advisor has their own philosophy when it comes to deciding the best fee structure for the client. Every client is unique in their needs and a financial advisor or financial planner will likely adjust their fee structure in the client’s best interest. There is no right answer when it comes to how fees are structured; but we stress the importance of asking the right questions to ensure you and your advisor are on the same page when it comes to compensation for their services.
Stay tuned for our next blog!