A penny for your thoughts

So you want to invest? You’ve got a variety of options but your final decision will depend on your ultimate goals

There are as many different goals, incentives and philosophies behind investment decisions as there are investors.   One person we know always seems to get annoyed with accumulating pennies – he does not feel that accumulating these in his pockets will amount to anything of substantial value.  In fact, he regularly throws them into the garbage, as he doesn’t feel they are worth the time it takes to roll them up and deposit them.  On the other end of the spectrum there are some individuals that will stop to pick up those pennies!  Call it being thrifty or having grown up in more difficult times but they understand that “crumbs make bread!”

Most people try to be thrifty with their money, and investors are concerned about how their financial advisor should be paid.  Most investors would agree that the real issue is not how much compensation should be paid to their financial advisor, but rather, is there a sufficient return on their investment.  In other words, compensation, or price, is only an issue in the absence of value.

What should financial advisors get paid?  Maybe a better question is, how should they be compensated? So when an investor meets with his or her financial advisor for the first time, there should be a clear understanding of expectations, including compensation to be paid to the financial advisor.  To answer these questions we need to look at the different types of investment accounts, as each type dictates a different method of compensation payable to the financial advisor.

If we unbundled all the financial terminology and the fancy product names we can break it down to five main types of investment accounts.  The five options are:

  • Bank / Credit Union
  • Discount Brokerage
  • Managed Accounts
  • Transactional Accounts
  • Fee-Based Accounts

There is no single option that is better or worse as the individual needs of an investor should be the guide in selecting the most suitable option

Do people still keep their money under their mattress?

Occasionally we hear of individuals who still follow this practice.  But we hope most people have confidence to trust the chartered banks and credit unions.  Local bank and credit union branches have qualified staff to not only discuss your day-to-day banking and borrowing needs but can also assist with explaining the available investment products available at their financial institution

Everyone likes a discount

Many firms have set up a separate business unit designed for individuals that would like to do trading themselves.  Discount brokerages often advertise their trading fees such as $9.95 trades or $29.95 trades.  Incentives may be offered to investors by offering a limited number of free trades for signing up for discount brokerage.  For regulatory purposes, investors of discount brokerage are not provided with advice or recommendations. The investor alone is responsible for his or her own investment decisions and whether those decisions are suitable.  So who should consider discount brokerage?  They should be investors with medium to high investment knowledge who want to research investments themselves or do frequent unsolicited trading.  They should also have the time to fill orders via phone or computer.

Even the person that throws away his pennies appreciates a good discount.  But, remember, like most things in life – you get what you pay for.

What are managed accounts?

Essentially, this is a customized mutual fund.  With this type of account, the investor is giving an external investment company (and not the financial advisor) the authority to manage their account.  This does not mean that the financial advisor is “off the hook.”  The advisor has four primary responsibilities:

  1. To understand the needs of the client:  the advisor has the responsibility to know the investor and determine if a managed account is appropriate.
  2. Manager selection:  external managers generally provide advisors information on their process and features of the managed account.
  3. Assisting the investor with the “customized” component:  typical types of customization are by region, asset mix and asset type).  For example, an investor may choose the following – Region: 70 per cent Canada, 10 percent United States, 10 per cent international and 10 per cent global; Asset mix: 10 per cent cash, 65 per cent equities, and 25 per cent fixed income; Asset type:  70 per cent large cap, 15 per cent medium cap, and 15 per cent small cap.
  4. Ongoing monitoring:  the advisor should monitor the performance of the manager (next to appropriate benchmarks) and explain the results to the investor.  Changes might be in order when appropriate and as agreed upon with the investor.

So, who should consider a managed account?  Investors who prefer not to be contacted regarding individual equity and fixed income trades, or those who travel frequently or prefer access to institutional style managers.

Are transaction accounts my best option?

Transactional accounts have been around since the full-service brokerage began.  Similar to discount brokerage a commission is charged with every purchase and every disposition.  The commission amount may fluctuate with full-service depending on the financial advisor’s pricing methodology.  The total value of the trade is generally the biggest factor, along with the number of shares and price per share.

A transaction account may be a good option for you, if you fit the following criteria::

  • Investors with investment assets under $150,000
  • Investors that prefer to buy and hold investments, so that little trading is done
  • Investors with a long term time horizon
  • Investors wanting access to research publications
  • Investors not requiring frequent withdrawals from the account
  • Investors that already have accounts set up in good order
  • Investors that are paying little or no income tax
  • Investors seeking infrequent investment advice

What is a Fee-Based Account?

This type of account charges an annual fee based upon a percentage of the total household assets under advisement.  This fee is assessed quarterly, based on the average total household account balance.  The fee usually allows a specific amount of free fixed income and equity trades and some firms offer unlimited mutual fund trades.

Advisors are not compensated per trade so each buy and sell decision is based on the investor’s strategic needs.  Commission and trading costs are not an issue.  In a fee-based environment, investors are reassured that decisions are driven solely by investment objectives.   If an investor’s account increases in value so does the compensation to the advisor.   Conversely, if an investor’s account declines in value, so do the fees paid to the advisor.  With this structure, the advisor has a direct incentive to work on having your account increase in value.  This should remove any perceived conflict of interest – advisors and clients are on the same side of the table with a fee-based account.

Who should consider a fee-based account?

  • Investors seeking ongoing objective advice
  • Investors with investment assets of $150,000 or greater
  • Investors wanting to eliminate annual administration fees and trading commissions
  • Investors wanting mutual funds purchased without front end or back end load fees
  • Investors interested in F-class mutual funds
  • Investors wanting access to research publication
  • Investors that are able to fully deduct investment council fees for non-registered accounts and this deduction can be claimed immediately (in the year paid)
  • Investors wanting to take advantage of ongoing total financial solutions (assessment of the investors borrowing & banking needs, tax planning, protection strategies, financial planning, retirement planning, estate planning, etc.)

The Jones Went Fee-Based All the Way!

After discussing the types of investment accounts with Mr. And Mrs. Jones, they chose a fee-based account because it was right for them – it was a natural fit.   The estimated annual fee of 1.25% or $3,125 ($250,000 * 1.25 per cent) is deductible in the year paid.  Assuming a 43.7 per cent marginal tax rate, the Jones would include $3,125 on schedule 4 which would result in tax savings of approximately $1,366 per year.  Factoring in the tax refund, the net fee amount of $1,759 represents an annual fee of approximate 0.7 per cent.

The primary reasons the Joneses decided on a fee-based account were:

  1.  Transparency – The Joneses are fully aware of the fees charged to manage their portfolio and they understand how their advisor is paid
  2.  Going fee-based ensures the Joneses and their advisor are aligned
  3.  Fees are tax deductible

We acknowledge that every investor has different needs, means, and goals.  Charging a fee or flat percentage has grown in popularity over the past several years.  While it may not be right for everyone, a fee-based account can be a very shrewd decision for investors such as the Jones.