Saturday, 30 January 2016

Your Financial Advisor and his hidden fee



Hidden Fees are almost synonymous with the financial world, patricianly financial advisors.  Millions of ordinary investors might or might not be aware of the dreaded Mutual Fund MER.  But for those who have retained a financial advisor, there are even more fees, hidden fees that are invisible. You probably have no idea what I am talking about, they are so hidden, that you will never see them in any prospectus.

One of the most common fees financial advisors charge is a 1% annual fee, based on the assets that are managed.  Every quarter or annually, this amount is deducted from a client's account and put into the financial advisor's firm's bank account.  Tho this insane amount of money being charged for financial services is a fee, it's not the hidden fee I was talking about.

It's what we called in University, the opportunity cost of your money every time this deduction occurs.  An example would probably help at this time.

Example

Ronald is 40 year old Director of Finance in a construction company.  He recently finished paying off his student loan and is approached by a financial advisor who is offering his services to manage his $500,000 RRSP account for a 1% annual fee.  Ronald has paid more than that on his student loans and his credit card interest rates are way higher than that.  He thinks this is an amazing deal, where can you get a financial advisor for 1%?  Sign me up.

Over the next 10 years, let's assume the market and Ronald's portfolio achieves that long term average of 7% gains per year.  So now we are 10 years into the future, and Ronald's RRSP account is now worth $892,000.

Over that same period, Ronald would have paid his financial advisor $68,290.  Even a director of Finance would think that is a pretty penny.

But at least Ronald can clearly see this money withdrawn from his account.  However as the quarterly or annual payments come out of his account, he is sacrificing all future growth or opportunity cost on that money.

If the payments were quarterly, Ronald's 1st payment would have been $1,271.  If he kept that money for 10 year, it would have been worth $2,459 nearly double its original amount.

Over the 10 years, Ronald would have given up $25,421 in missed returns.  Add that to the actual fees that he paid, and Ronald is nearly out $94,000 over 10 years.  Nearly a fifth of his original $500,000 portfolio.  Now can you see why financial advisors are so friendly, if they have 5 clients like this, they are set for a long time.

Let me stop here and make one thing clear.  I am not saying all financial advisors are only in it for the money or that they do not provide a valuable service, after all most of them are friends you trust or family members.  However if you do use a financial advisor or money manager, take a long hard look at my example above with Ronald and ask the advisor, "Am I getting my money's worth?"

If the answer is no, do something about it.  Relatives, neighbours, and your financial advisor will tell you that you are making a mistake, or that investing is too complex (I've shown in this blog it is not).

Start by crunching your own numbers.

But don't waste time, with every day that you have your advisor, your losing money whether you see it or not.