Seeking Redemption (Fees)

 In Value For Money Investing

Over the last couple of weeks, I have been getting multiple inquiries about redemption fees so I thought this month I would take the time to look at this issue.

The possibility of redemption fees arise when you purchase a mutual fund with a deferred sales charge (DSC). Like no load funds, the mutual fund company does invest 100% of your deposit with them BUT if the fund is sold within a specified amount of time it will trigger redemption fees. This is due to the fund company not having sufficient time to recover the investment it made in obtaining the sale. Remember, these mutual funds have annual charges deducted (included in the management expenses or MER) each year and the fund company is counting on making money on you annually for enough years to satisfy their business plan. The redemption fees are usually a sliding scale, from about 6% to 0%, over a seven or eight year period.

If you are unhappy with the fund you are in, you may usually transfer it to another fund within the same class of funds at the same company without triggering the fee. It is usually required to move to a similar class of funds because the management fees are set differently on DSC funds than other classes. The mutual fund company is happy to be able to continue to charge you as planned, albeit in a different fund. With many mutual fund companies having large offerings of funds, this is very commonly the route used to get out of a fund you are unhappy with. Interestingly, the most common sliding scale is a seven year period and the average holding period for a mutual fund in the Canadian marketplace has always hovered around seven years. Huh! I guess Canadians as a group do not like to pay redemption fees.

If you decide that you would like to change fund companies before the expiry of the set time, you will confront these redemption fees. Now the fee is there because the fund company remunerated a sales person when the fund was sold to you (some companies will try to characterize it otherwise). This means you likely do have an advisor involved with your account. Before doing anything else stop and evaluate whether you need or desire an ongoing advisor. An advisor costs money, (between upfront commissions and annual trailer fees the advisor is earning 1% a year on average) and if you need one, you will pay in some form. If you are about to transfer your funds to another advisor that is also compensated by the fund company, either through DSC funds, Front Load funds or no load funds (ironic name) with a large trailer, think again. You will trigger the redemption fee AND still have a high MER (management expense ratio). You have made your situation worse, not better. So maybe we need to also think about the advisor, not just the fund company.

For new or small investors, mutual funds do provide a wonderful way to enter the markets beyond GICs. However, a high percentage of mutual funds are sold by commissioned advisors, many for whom the key word is commission, NOT advisors. This unfortunately often includes the banks, who are also product driven distributors. Additionally, the problem is not always only the advisor, but the timid investor, who is afraid to ask to get what they are paying for. Demand a good, complete financial plan of your advisor or financial planner. Expect it and ask for it. That is what you are paying the high MERs for. If your advisor is unable to provide it, then you have a clear answer and it is time to move on. As always, do be vigilant in understanding the advisor`s motivation for any recommendations they make at this time.

If you can find an advisor that specializes in lower cost funds or you are going to manage your own account, you can now evaluate the decision to dump your existing fund company on a return on investment basis. If your current funds have an MER of 2.5% and you can reduce the MER to 1.5% with another comparable fund with an advisor attached, then you have a basis for saving 1% per year. It may take you five or six years to reap the savings, so not much pay back for making the change. You will need other reasons like lack of confidence or poor service or inability to provide a good financial plan, etc. to trigger a change. However, if the current cost is over 4%, like I saw just last week, very different story with lots of opportunity to save. Before we leave that thought, just like in all your other shopping experiences, there are comparable products at very different price points, you just need to know where to shop. Few funds in Canada are completely unique regardless of the marketing materials that say otherwise, so lowering your costs is always an option.

Now if you have decided to abandon the use of a company paid advisor altogether, for doing it yourself or using a fee only advisor, you can get a much different result. If much of your holdings are in very large funds that tend to track the index, move to an index fund or ETF. MER costs will fall below 0.5% and now with a 2% yearly savings you will have your money back in just a few years. If you seek out a fee only planner, set your expectations correctly. It is difficult to provide any worthwhile detailed plan for under $800, which is a high percentage cost when you only have a few dollars to invest. With additional fees each year for review, you may save some, but if you need or desire an advisor, it will be an ongoing cost. The average fee only planner is charging $200 to $250 per hour, but many do have discounts and lower rates to help out small or new investors, we do.

Value For Money Investing means we wish to allocate and use our hard-earned resources in order to improve investment outcomes in a continuous and sustainable way at a fair and equitable price. In other words, achieve good investment returns AND receive fair value for the services provided. Costs do matter!

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