/ / The Case FOR Deferred Sales Charge Fees on Mutual Funds
Investment Strategy

The Case FOR Deferred Sales Charge Fees on Mutual Funds

Mutual Fund Fees
Photographer: Alexander Mils | Source: Unsplash

There’s a lot being said about Deferred Sales Charge Fees (DSC) on Mutual Fund purchases. While certain key parties in the financial world are against them, I happen to think they are a good thing. Allow me to make my case.

How Great Investors Differ From Average Investors

Who makes money in the stock market? Some traders can have a good year or two. But, the best results come from people who carefully analyze the value of a stock and buy undervalued assets, then wait patiently for the market to realize the true value of the company. The leading example of this style (called “value investing”) is Warren Buffett at Berkshire Hathaway.

What do small investors do when they start to get active in the market? They look for the next hot stock. They don’t do enough research, and often taking tips from friends that turn out to be ill-informed. Most self-directed investors lose money because they follow their emotions, rather than a logical approach to investing. So many people were trading too often in their accounts and losing money on those fees, that the industry decided to do something to help protect average investors from their own emotions.

Advisors were given a slightly larger (6% versus 5% for the alternative) commission to educate clients on the need to buy and hold investments. Clients were also rewarded. In fact, for the long term small investor, Deferred Sales Charge Fees funds represent the lowest cost of fund ownership. The commissions paid to the advisors were paid by the fund, so long as the client remained invested for 7 years or more.

This strategy allows time for a good investment to mature.

Why is This Coming Up NOW?

With $1.75 Trillion CDN in investments, the mutual fund industry is huge! There are more than 21,000 funds, portfolios (funds that invest only in other funds) and Exchange Traded Funds (ETFs). That’s more funds than stocks listed on the Canadian markets! Everybody wants a bigger share of that pool. The best way is to offer more “selection”. The average of the Big 5 Canadian banks is well over 1500 funds and portfolios, meaning they offer over a third of all funds available to Canadians.

It’s impossible for that many mutual funds to outperform the overall stock market. The market cap of Canadian stocks is $2.3 Trillion, so mutual funds in large part ARE the market. Most of the funds offered at the banks fall into the under-perform category.

Everybody is trying to grow market share. One way to do that is to kill off the competition. The campaign against Deferred Sales Charge Fees (DSC) funds appears to be a strategy from the banks to do just that.

What’s Wrong with Financial Advice From a Bank Branch?

The banks, quite naturally, segment their customers. The most common segmentation when it comes to investing is by the value of your wealth. Unless your net worth (excluding your house) is in excess of $500,000 you won’t be able to invest in the best funds through your branch. Financial up-and-comers don’t go to the branches for advice.

So, who does? Average people, with a few thousand to invest every year in an RRSP. The investment people at the branch ask just the right questions to convince uninformed people that they should put their money into a portfolio so that the bank can make the investment decisions on their behalf. The cost of these portfolios? The average portfolio has a Management Expense Ratio of over 3% once you add in the MERs of the funds the portfolio holds.

Yes, the banks do not charge commissions, but that doesn’t mean your investments are at no charge. But your biggest objective shouldn’t be the lowest fees in any case. Instead, it SHOULD be getting the largest return AFTER fees. Every single bank portfolio on offer in Canada underperformed the Morningstar benchmark as of March 2018. The average underperformance was just over 3.5%.

Do I Have Options?

There ARE fund managers who outperform the market for years, even decades in some instances! I have a link on this site where you can download a report showing the performance of my funds over the last 5 years. My only other investment is in Berkshire Hathaway. None of my investments are classified as High Risk or Speculative. They are suitable for the average pensioner (which I am). My returns, on average, have been over 16% for this period. Your bank advisor is probably telling you that you should be happy with 6%!

Where can I get these returns? From an independent advisor – one working for a company that doesn’t sell their own funds!

These people need to get paid for the time they spend getting educated, licensed, keeping up with the current regulations, finding great products, and helping average investors understand ALL the options available to them.

How do you know if your advisor is recommending funds that you can just buy and ignore (other than a semi-annual review)? Get his or her recommendations, and see how they have performed for the past 5 and 10 years. If they aren’t at least 8% or higher (and preferably over 15%) then look for a better advisor.

Find an advisor who has funds that use a “high commitment value-based” model, the one proven to outperform over time. Then, once you place your money, try to ignore the daily noise on the market, knowing that your fund manager is using that noise to increase your eventual profits.

Be happy to be in Deferred Sales Charge Fees (DSC) funds. You are helping an industry professional help you and others to use the lowest total cost investing model available to smaller investors.

To demonstrate that, I’ll quote from a study on embedded commission models conducted by the Investment Funds Institute of Canada, the licensing organization for Mutual Funds Dealers and representatives, charged with protecting the interests of Mutual Fund investors said the following in a recent survey…

In markets that have experienced a natural evolution away from embedded commissions or where embedded commissions have been eliminated through a regulatory directive, there is evidence that modest investors pay more for, and generally have less access to, advice than they do in markets where embedded fee models exist.

Advice and the Modest Investor: A Canadian Perspective, Investment Funds Institute Canada (2017)

Comments? Questions? Contact me at cadillacwealth@gmail.com

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