As noted in my Wealthy Boomer blog here, American indexing guru and author Charles Ellis [seen in photo on left] gave Canadian money managers both a history and arithmetic lesson on Tuesday. His point in a nutshell is that annual mutual fund Management Expense Ratios (MERs) of 2.5% or so (in Canada) are “terrible” but even the investment counselling fees of 1% (plus or minus 50 basis points) are also excessive.
These numbers may seem small when expressed as a percentage of assets but Ellis said the way to look at it is as a percentage of the return generated by active managers. So even if the active manager could generate a pre-fee return of 10%, the 2.5% fee takes that down t0 7.5%, so amounts to a 25% reduction of the return: or ten times the 2.5% figure that seems so insignificant. If returns are more likely pre-fee 6 or 7%, then a 1% fee takes it down to 5 or 6%, and amounts to a 15% reduction of return, he said.
Ellis himself prefers market-cap weighted index funds or ETFs of firms like Vanguard Group (which recently set up shop in Canada.) Investors can buy the “market” for as little as 10 basis points (0.1%), which long ago was a figure that customers of money managers were accustomed to pay. But as he related in his Monday talk in Toronto, customers didn’t balk when one firm hiked it to 25 beeps, others followed suit and eventually even a full 1% didn’t seem out of line.
This cost-conscious approach consistent with Findependence Day model
None of this should surprise readers of this blog, since the Findependence Day model cuts costs to the bone by emphasizing use of discount brokerages to cut commission costs, and then implementing trades of ETFs or index funds, the fees of which will range from about 8 or 9 beeps to 55 beeps for most mainstream ETFs, and perhaps a bit more for some esoteric ones. Of course, you can also try and pick your own individual securities, although Ellis would probably call that the “loser’s game,” as per the title of his book, Winning the Loser’s Game.
The third point is that you can still benefit from good advice by engaging a fee-only financial planner who charges by the hour, month, quarter or year, or perhaps by the project (which might be a financial plan or portfolio assessment). You can also go the fee-based route but keep in mind that a 1% fee will be on top of the underlying MERs of the ETFs, which could easily run 1.5% or so. For some investors, especially buy-and-hold investors who don’t trade frequently, a traditional commission-based full-service advisor could make sense from a cost perspective, at least relative to a high-fee-based alternative.
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If you’ve been monitoring my FP columns and Wealthy Boomer columns the last week (see scrolling lists to the right of this blog), you’ll see a recent focus on financial planning. My Saturday column in the Financial Post simply reported on the annual symposium held last Wednesday by the Financial Planning Standards Council.
Even so, readers and even certified financial planners (CFPs) themselves seem to be surprised by the revelation by the cream of the FPSC’s own membership that many clients of financial planners don’t automatically receive a comprehensive financial plan at the start of the relationship. My blog on Monday shows some of the reaction, including from one RFP or Registered Financial Planner (who regard themselves as an advanced form of CFP). See IAFP.ca.
Financial planning is key element of The Findependence Day Model
Let me make it clear, as anyone who has read the book and this web site devoted to it, that I’m fully in favor of most investors engaging a financial planner, ideally a fee-only or at least a fee-based one, as opposed to one paid by commissions on product sales. I’ve argued that the heart of what I call The Findependence Day Model is a self-directed investor who buys ETFs or individual securities through a discount brokerage but ALSO receives guidance through a fee-only or fee-based advisor or financial planner.
In the book, there are not one but TWO characters who are CFPs: Theo, the grizzled veteran who has achieved his own Findependence Day and charges a low annual fee for clients who want to mimic his personal portfolio; and Bernie, the frugal financial planner who moonlights as a record store owner.
It should be obvious that if you’re paying someone to be your financial planner, then you should be getting a financial plan. If you’re paying on a fee-based model (i.e. asset-based), then the comprehensive financial plan should be included. If you’re paying on a fee-only basis, then it’s quite acceptable for the financial planner to invoice you for the preparation of this detailed plan prepared at or near the onset of the relationship.
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