Front-load fees: a cautionary tale
This is a cautionary tale about the importance of understanding the terms and the fees when you are working with a financial advisor selling you financial products. In short, run away as soon as you hear “front-load fees”.
When our kid was born, we got contacted by a financial organization offering RESP (Registered Education Savings Plan). They said they got our details from some sign-up list for free baby stuff. They seemed nice, they wanted to do a home visit and tell all about their products. At this point we had never heard about RESP before, which really we should have, considering how attentively we researched other baby-related questions. The advisor visited, told us about the benefits of RESP. We signed the papers, set up a monthly transfer of $50, just to try it out.
About a year and a half later, I decided to check on the account balance and requested a statement. To my surprise, after 18 months we had just over $180 in the account. By that time, we have contributed $900 to this RESP. Where did the money go?
And then I remembered that one phrase the advisor told us, something about the contributions first going towards the fees. The advisor also said that once the fees are paid, then the money in the account starts accumulating with no further obligations from our side. In my early parenthood fog of sleep deprivation and stress this somehow seemed like a great idea. Just pay the fees up front and no more worries.
Can you see what is wrong with it?
Let’s do the math. You can contribute to RESP until the year the child turns 17. With $50 a month, our estimated contributions over 18 years were $10,800. Fees were 10% of the projected contributions, or $1,080. With the contribution schedule we had, 10% would be paid in about 2 years. Fees would consume almost all contributions of the first 2 years since the start of RESP. Due to the math of compounding interest — assuming 6% annual return through a slightly aggressive portfolio — these fees would turn into almost $3,000 by year 18. By the time our kid would get to use the accumulated RESP funds, the financial organization would have tripled the amounts received from us as front-load fees early on. Our contributions plus the government 20% match would turn into $19,000. After 18 years we would not have even doubled our contributions. We would have given away almost 14% of our RESP to the financial organization. For what exactly? How is it even fair?
We felt it was not fair at all. What did we do? Fees we paid were a sunk cost, and we were able to recover a large portion of them (proportionally to the time we had had the account open). We consider it now the price we paid for our financial education. Could have been much worse. We switched to a robo-advisor and later, to a self-directed account.
The moral of the story? Take time to understand how the fees will be charged, how much and when. Read your contracts with financial intermediaries (banks, mutual funds, other financial organizations) right now. Understand how much you may expect to earn and how much will be earned by your intermediary (financial organization, bank, robo-advisor). Understand whether this price is fair for what you are getting in service and convenience. And don’t invite financial advisors to your home when you are sleep-deprived.
Read more about RESP account basics in my mini-series.
Disclaimer: I am not a certified financial planner and this article does not constitute financial advice. Please do your own research before acting on the material of this article.
