From an early age, Kelly Hall has been savvy with money. She started saving at age 10, buying savings bonds and GICs. She opened an RRSP at her first opportunity at age 18.
She started investing in mutual funds in her early 20s.
"I read books about investing in my spare time, my favourites being The Wealthy Barber and The Millionaire Teacher," says the 29-year-old Winnipegger. "I wouldn't say I know everything, but I believe that I am fairly financially literate."
Yet she recently got a shock when she wanted to access her $35,000-RRSP portfolio to make use of the Homebuyer's Plan that allows Canadians to withdraw money from their registered accounts -- tax-free -- for a down payment.
"Little did I know, my money was being trapped by my financial adviser without my knowledge; the reason being deferred sales fees," she says.
Hall says she faced paying about $1,400 in fees to access her money invested in mutual funds with Investors Group if she wanted to use it for a down payment on a home.
She balked at the move when she found out she would pay a penalty -- a deferred sales charge -- as high as 5.5 per cent on some of her investment, a cost she says she does not recall ever being made aware of when she first started investing with the firm.
Deferred sales charges -- or DSCs -- are not uncommon in the Canadian mutual fund landscape. A 2012 discussion paper released by the Ontario Securities Commission says about 20 per cent of the funds under management in Canada carry these fees, which essentially compensate the adviser for selling a fund.
The fees are paid to the adviser as trailing commissions by fund companies out of the funds' annual management costs, called the MER (management expense ratio).
As long as investors remain invested in a fund or switch to another fund within the same fund company for a number of years, they do not incur any direct costs other than the MER. But they do pay the fee -- the DSC -- if they choose to cash out and invest somewhere else. Money contributed to a fund with a DSC structure is usually charged a 5.5 per cent fee in the first two years for early withdrawal, and it generally decreases each year thereafter until after the fifth or seventh year, after which fees no longer apply.
DSC's upside is investors can purchase funds and receive advice for a relatively low cost, particularly. It's a structure that can be well suited for investors with smaller portfolios and able to make only modest contributions to their RRSPs.
Yet the fee structure can also be the least investor-friendly of available adviser-compensation schemes, because it can compel investors to stick with losing investments or advisers who provide unsatisfactory help, industry observers say.
The DSC structure also presents 'an inherent conflict of interest' because instead of the client paying the adviser directly for advice, it's the fund company compensating the adviser, says Fabio Campanella, a Toronto-based financial planner and portfolio manager with Campanella McDonald Chartered Accountants.
"Usually, it's the other way around -- the client pays the lawyer, the accountant or the engineer," says Campanella, who has written op-ed pieces critical of DSCs, also known as back-end fees. "So it begs the question: who is the real client -- the person who approached the adviser for help or the mutual fund company?"
Regulations stipulate investors must be made aware of DSCs when purchasing funds, and many investors do end up choosing DSC funds when presented with other choices, such as paying a fee directly to the adviser, because on the surface these investments appear to involve no cost as long as they remain in the funds, Campanella says.
"In most cases, clients will say 'screw that! I'm not paying it (an up-front fee to the adviser). Let the mutual fund company pay on my behalf,' because it doesn't change the overall management expense ratio of the fund," he says.
"So everybody is happy. That is, until they want to pull their funds out and they're faced with paying the fee."
What often happens is when investors decide they want to take their money somewhere else, they do not recall whether they were clearly informed about the fees when they first purchased the funds, he adds.
Yet they likely had signed a consent form indicating they were aware of the fee structure.
"But by the time they want to pull the money out, they've forgotten the details," he says. "The fact is they were probably concentrating more on what the adviser is putting their money in, so they weren't really focused on the back-end fees and other options."
Senior vice-president at Investors Group Todd Asman says regulation requires sales staff discuss fee options on mutual funds prior to selling an investment.
"Clients also receive a disclosure document that clearly outlines the fees and commissions associated with the particular fund," he states in an email response to the Free Press.
Furthermore, he states the DSC structure is an economical way for clients to pay for advice that includes financial planning.
"The benefit to clients receiving advice is proven," he states. "Recent independent research has shown that Canadians who work with an adviser are likely to have approximately four times more wealth than those who are not advised."
Yet paradoxically, DSCs can also hurt investors' finances because their financially punitive structure can dissuade investors from switching funds, and firms, when they believe they have received unsatisfactory advice, including guidance that has led them to invest in funds with lacklustre performance, says Ted Rechtshaffen, president of Toronto-based advisory firm TriDelta Financial Partners.
"The typical comment to justify DSCs I hear from the industry is, 'We are protecting the investors from themselves, who are trying to make short-term decisions on what should be long-term investments,' but I would translate that as, 'Keep them here no matter what,' " says Rechtshaffen, who has also written op-ed pieces critical of the DSC structure.
"As an adviser, however, I couldn't imagine working with clients who are desperate to get out and they only stay because they feel trapped."
In the end, Hall did end up purchasing a home using money from her TFSA, which was set up by her adviser at Investors Group.
"But it still would have been nice to have that RSP money because the mortgage would have been less."
As for her $35,000 in RRSPs at Investors Group, she is waiting until all DSCs expire. So for the next few years, the money is staying put, but any RRSP contributions are now invested at her bank in mutual funds that do not have DSCs.
Hall says the ordeal has been a learning experience, albeit a disappointing one she doesn't want others to have to inadvertently go through.
"I want people to be aware of where they're investing, because they can be charged a lot of penalties if they want to make a switch."