As with most things in life, the statement ‘there is no such thing as a free lunch’ rings true for investing. If there is one thing that can affect your portfolio, decreasing your returns and impacting your ability to meet your financial goals, it is paying unnecessary investment fees.
Most people understand the concept of investment cost. Not everyone understands the complexities behind fee structures and the true cost of financial products. You may be wondering what each type of fee is really for or how your costs stack up to the average Canadian. Or, you may not even know how much you are paying. No matter your degree of knowledge, this guide is for you. We answer all your questions about investment costs and how to negotiate lower fees.
Table of contents
- What are investment fees?
- What fees do you pay when investing?
- How are investment management fees calculated?
- Can you claim investment fees on your taxes in Canada?
- Are investment fees negotiable?
- How do you avoid paying fees when investing?
What are investment fees?
Investment fees are the costs associated with receiving portfolio management advice, owning financial instruments, and maintaining your accounts. The exact definition depends on the type of investments you hold in your portfolio and the professional advice you are receiving. In reality, the term is all-encompassing and can apply to any number of costs.
Common types of fees
There are as many types of fees as there are investments. The best way to look at this list is to split the investment fees into account fees and fund expenses.
- Investment management fees, or management fees, come with hiring a wealth advisor. It is most common to see management fees expressed as a percentage of a portfolio’s market value in a ‘fee-based’ account structure, with no additional transaction charges.
- Transaction costs include commission charges and fees for purchasing or selling an asset. Both full-service brokerages and discount brokerages can charge on a per-transaction basis.
- Account administration fees will show on the account level based on the fee structure of the overall portfolio. Typically, the brokerage charges these annually for registered accounts if the account holder does not pay other investment management fees.
- Withdrawal fees may apply when you take out money from registered Canadian investment accounts such as an RRSP or a TFSA, especially when using a discount brokerage.
- Transfer out fees typically happen when you move your accounts from one brokerage to another. It is quite common for the receiving financial institution to reimburse at least a portion of this cost.
- The management expense ratio (MER) represents the total cost of owning a mutual fund or exchange-traded fund (ETF). See below for more details on this expense type and how to calculate it.
- A front-end sales charge, or front-end load, refers to any upfront charges when purchasing a mutual fund.
- Deferred sales charges (DSC) happen when you sell a mutual fund under the back-end load option. The DSC, or trailer fee, declines when you hold the investment for longer, though the amount can be considerable in the initial few years after purchase. On June 1, 2022, funds that use the DSC option will no longer be available in Canada.
- Performance fees apply to an investment’s profits and incentivize the fund manager to achieve positive returns. The manager will receive a percentage of the profits as a bonus for excess gains. Performance fees typically apply to hedge funds, which are notorious within the investment industry for high costs.
What fees do you pay when investing?
The fees you will pay when investing depend on the type of accounts you have, the investments you hold in them, and your overall net worth. For example, if you enlist the help of a professional investment advisor, you may end up paying an investment management fee on a percentage basis. However, if you choose to invest in a do-it-yourself manner through a discount brokerage, you will pay account administration fees and transaction costs, including commission.
If you choose to invest in structured financial products, such as mutual funds, hedge funds, or ETFs, you may also be paying a management expense ratio (MER) and a performance fee. See below for more information on the definition of MER.
How are investment management fees calculated?
In a ‘fee-based’ account, management fees are based on the portfolio’s current value, also known as its market value. The investment fees calculation is the value multiplied by the cost in percentage terms.
For example, consider investors John and Jane Smith with a portfolio of $1.5 million. Imagine they are working with a wealth manager who charges 1% under a fee-based account structure. Under this scenario, the Smiths would be paying their wealth manager $15,000 per year based on the calculation and multiplying $1.5 million by their 1% fee.
Instead of charging a percentage, some investment advisors charge on a commission basis — though the industry is moving towards a fee-for-service approach. Suppose a wealth advisor charges fees on a commission basis when a transaction occurs. There will be a commission charge that is a percentage of the transaction or a flat dollar amount in this case.
What is a management expense ratio (MER)?
As briefly outlined above, the management expense ratio (MER) is a type of investment fee. While it is expressed as a percentage, it is different than a fee-based account. Instead, MER is the total cost associated with owning a fund. The expenses included in the MER are anything related to the fund’s operations, including administration, accounting, trading costs, taxes, etc. It also covers management fees for the team that runs the fund.
The MER is a percentage of the fund’s market value or assets under management (AUM). The calculation for the exact dollar cost is the fund’s size multiplied by the percentage.
For example, consider a mutual fund with a 1.8% MER. If the fund size is $1 billion, this means that the total annual expense for the fund is $18 million. The calculation for this is $1 billion multiplied by 1.8%. If the AUM is only $1 million, the expense is only $18,000 for the year.
Regardless of the exact dollar amount, you will not see the MER charge in your account as the investor. Instead, the MER is deducted from the overall investment return. This means that any client statements or advertisements will show the return after these charges, also referred to as ‘net of fees’.
Low MER vs high MER
It is important to note the potential for a wide range of percentages for a fund’s MER. Funds that follow a passive investing strategy will have a lower fee. Funds that trade on a more active basis tend to have a higher MER as consistent transactions will drive costs up. For example, a fund that tracks the S&P/TSX, Canada’s main index, is called an index fund. This index fund is likely to have a lower MER than a fund that invests in value stocks. This is because the index fund will make significantly fewer trades than a value fund that buys and sells equities more frequently.
In Canada, financial firms must disclose the MER to investors before purchasing. To fulfill this requirement, the brokerage will send a fund facts page to each prospective investor and have them acknowledge the terms of the document. While this may seem unnecessary, it is another step in ensuring investors are aware of the situation and that investment companies provide complete transparency.
Management fee vs expense ratio
A management fee is not the same as the expense ratio or MER. Though they both include costs associated with a fund, the MER consists of all management and operations costs, while the management fee covers only the costs of the fund’s management team. For this reason, the MER will be a greater number than the management fee.
Can you claim investment fees on your taxes in Canada?
You can deduct some investment fees on your tax return in Canada, though not all. It is possible to claim fees for all non-registered investment accounts on your taxes. This includes any investment management fees, administration fees, and trading costs.
Registered accounts are already tax-deferred or tax-exempt, so these investment fees are not included in your taxes. Accounts that fall into the registered category are a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), Locked-In Retirement Account (LIRA), Life Income Fund (LIF), and a Tax-Free Savings Account (TFSA).
What is a typical investment management fee?
The fee structure used in the wealth management industry differs from company to company. Each firm will include different costs and provide certain perks for their clients.
Many companies will bill each client a percentage of investable assets with a lower percentage for a higher net worth. For example, an investor with $500,000 in investable assets could pay a 2% management fee, while someone with a portfolio of over $3 million might have an investment cost of less than 1%.
While the percentage-based system is similar across the industry, the exact percentage and the services covered will differ. For example, some firms may include financial planning as part of their costs, while other firms may provide private banking services but only offer a discount on financial planning. In some cases, comparing firms could be like comparing apples and oranges. It is difficult to gauge what a typical portfolio management fee really is.
Related Reading: Asset Management vs. Wealth Management — What Is The Difference?
Are investment fees negotiable?
Some investment fees are negotiable, though certain types are not. For example, costs associated with owning a mutual fund or ETF are not typically flexible though each fund class will have different fees. On the other hand, investment management fees are usually negotiable if you are working with an investment advisor.
How to negotiate fees
The secret to negotiating investment fees is simply to ask. Many people do not realize that it is possible to have certain costs discounted or, in some cases, waived altogether. Keep in mind that this is not the case every time. If you reach out to your wealth management firm and ask, the worst answer you might get is ‘no.’
Wealth advisors can often offer a discounted rate based on the value of the assets that you hold with them. By consolidating your accounts with one financial advisor, you are in a better position to negotiate investment management fees.
How do you avoid paying fees when investing?
If you decide to manage your investments through a self-directed account, it is possible to avoid paying an investment management fee — though there are still fees that you are required to cover. You may not be paying a wealth manager a percentage fee, but you will still need to pay the cost of each transaction, including commission fees and account maintenance fees. Typically discount brokerages charge annual fees, and some will also have costs associated with withdrawals. These fees are usually waived when you enlist the help of a wealth manager and a full-service brokerage. This is especially true if you are paying based on a percentage of your assets.
If you decide to proceed with self-directed investing, you also do not receive the added value a wealth manager can provide. These value-added services can include professional advice, portfolio allocation expertise, comprehensive financial planning, insurance and tax strategies, and estate preparations. Paying for a wealth manager can provide many benefits, and choosing to forgo the service to save on fees may work to your disadvantage in the long run.
Fees associated with investing can impact your portfolio, especially in years of muted returns. Just because investment fees affect your accounts, it does not mean you need to avoid them altogether, though. To a certain extent, the cost of investing is avoidable and necessary to help your assets grow. Understanding the investments that you hold and the fees you are paying is the first step to evaluating whether you can negotiate a lower cost or if you are indeed getting your money’s worth of advice.
Receiving personalized investment advice is key to preserving your wealth and meeting your financial objectives. When it comes to your financial future, enlisting the help of a professional wealth manager can be worth every penny.