Q: My husband and I have RRSPs with an advisor and our holdings are all in mutual funds with deferred sales charges (DSCs). We also hold accounts with a discount brokerage, where I hold ETFs that have performed really well. I’m ready to take the plunge and transfer our advisor accounts to our discount brokerage. My father is advising me to sell all the mutual funds and eat the DSCs so we can transfer them immediately. Can you tell me the pros and cons of this strategy and, in your view, if this would worth it for us?
— Jane and Ken D.
A: I’m going to side with your father on this one. Sometimes it pays to tear the bandage off quickly rather than prolonging the pain.
Deferred sales charges are one of the fund industry’s most destructive practices. When you buy a mutual fund with a DSC, you pay no upfront fee. However, if you sell the fund and change advisors before a specified period (often six or seven years), you’ll pay a heavy penalty. DSCs often start at 6% and decline gradually each year, so on a large portfolio those charges can easily cost you thousands of dollars.
Mutual fund dealers and advisors often defend DSCs as a way of encouraging long-term investments. They’re not: they’re a way for advisors to hold clients captive. They’re also a disincentive to provide ongoing service, because dissatisfied clients can’t leave without being slapped with a huge penalty.
If you’re planning on leaving one advisor for another, it might not make sense to eat those deferred sales charges. Consider an investor with a $100,000 portfolio who is paying 2.5% in annual fees for her mutual funds and would face a $5,000 DSC if she sold them today. If she were to move to a different advisor who charged 1.5% with no DSCs, she would save $1,000 a year. But at that rate it would take five years to make up that initial $5,000 penalty.
However, in your case, Jane and Ken, the plan is to move to a self-directed ETF portfolio, which will be much cheaper. To continue the same example as above, if you can reduce the fees on your $100,000 portfolio from 2.5% to 0.25% with ETFs, you would need barely two years to break even after paying a $5,000 DSC. That’s why your father’s advice might make sense here.
Before making your decision, be sure you’re working with hard numbers. Ask your current advisor for a schedule of all the deferred sales charges that would kick in if your sold your funds, as well as the maturity dates (after which no DSCs would apply). Then calculate how much you would save in fees every year if you switch to ETFs through your discount brokerage. If waiting a month or two would eliminate or reduce some charges significantly, it is probably a good idea to hold your nose and wait. But if you would otherwise be locked in a poor relationship for several years, it may well be worth it to cut your losses and start fresh with a lower-cost portfolio.
—Dan Bortolotti, CFP, CIM, associate portfolio manager with PWL Capital in Toronto