Tuesday, January 24, 2012

Hidden Costs in Private Investing

An acquaintance of mine I’ll call Carl mentioned that he invests with RBC’s private investing service where he pays a fixed percentage fee on his portfolio each year rather than paying management fees on all of his funds. I asked what other fees he pays and Carl’s reply was that there were no other fees. He said that he only pays the percentage fee and is pleased that he negotiated it below 1% per year on his sizeable portfolio. I just had to check into this.

It turns out that Carl’s portfolio is mostly invested in RBC’s Series O Private Pools. Carl was partially correct in that he does not pay any management fees on these funds. But, he does pay a management expense ratio (MER) and a trading expense ratio (TER) on each fund.

Many people think that management fees and MERs are the same thing because of the similar names, but they have differences. MERs contain the management fees plus a few other things like administrative costs and taxes. Outside of the MER are trading costs. So, in addition to his negotiated yearly fee, Carl pays administrative costs, trading costs, and taxes.

All of this was explained in the fund facts sheets. For example, the RBC O'Shaughnessy Canadian Equity Pool Series O has an MER of 0.11% and TER of 0.26%, for a total cost of 0.37%. Among the equity pools, the average added cost was 0.36%. Among the bond pools, the average added cost was 0.04%.

These costs may not seem like much, but remember that they are on top of the yearly fee that Carl negotiated. Adding 0.36% to this fee for the equity funds makes Carl’s negotiating skills look less keen. And while the added costs for bond funds are very low, the negotiated fee is quite high for fixed income investments.

Carl was quite surprised to learn all of this. While this information is available on the RBC web site and may well have been disclosed to him in documents he received, Carl’s understanding from talking to RBC representatives was that his only cost was the negotiated fee. This misunderstanding likely stems from not realizing that there are fees other than management fees.

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