Trail commissions are small ongoing amounts paid to advisers in the years after you buy the investment. The sums involved appear to be small, ranging from between 0.1% and 1%pa, though in many cases there is no way to avoid them. When you go through one of the discount brokers on the Internet that rebate up front fees, they still take the full trail commission for as long as you hold the investment.

Trail commissions are the major form of remuneration for advisers today. In the early days of the industry advisers were paid a very large initial commission but very little on an ongoing basis, which is why old funds usually have big exit fees. Today the initial commission has been drastically reduced, and a trail commission is paid instead.

The idea is presumably to reduce the incentive for advisers to switch client's money around excessively, and to provide the adviser with some incentive to provide ongoing service, as opposed to just selling something and running off to the next sale. Unfortunately, few advisers see the trail commission as in any way committing them to provide any ongoing service, they may still just sell you something and then leave, checking back from time to time only to see if they can sell something else.

Trail commissions are usually included in a fund manager's management expenses ratio (MER), which is disclosed in the prospectus. It is relatively rare for fund managers to have a facility that allows the trail commission to be reduced, in most cases it is non negotiable. If you call a fund manager and tell them that you don't want your former adviser to receive a trail any more they might cut it out (though they don't have to), but this will not come back to you in the form of lower fees, the manager will keep the trail for themselves. The situation is the same if you approach a fund manager directly instead of going via an adviser, the fund manager keeps the trail commission and you aren't any better off.

It is perhaps very convenient to advisers that this is the case. Most will tell you, quite truthfully, that rebating trail commissions is impossible. Of course if they wanted to they could give you a cash refund or offset the trail against some other fee, but they are speaking the truth when they say trail commissions can't be rebated (automatically by the fund). An even better solution would be to boycott managers that refuse to allow trail commissions to be rebated, such funds do not necessarily have the investor's best interests at heart.

(I have no objection to fund managers offering trail commissions as a remuneration option to advisers, but I really hate it when I am not given a choice.)

Trail commissions are important to advisers because the value of a financial business is equal to a multiple of the recurring income. If advisers were simply to sell products that had no ongoing trail commission, the value of their business would be almost nothing. Many advisers make a six figure sum annually on trail commissions alone, multiply that by four or five and that is the value of their business. This is why even most "fee for service" advisers refuse to rebate trail commissions or recommend funds that don't pay them. It is relatively easy to find an adviser that will charge a fee for preparing a plan and rebate all entry commissions, but less simple to find one that will rebate all the trail commissions as well. Advisers that operate on a strict fee for service basis, without trail commissions, are extremely rare. I know of only a few such advisers in Australia.

How I avoid trail commissions

It is true that most funds don't provide an automatic facility to refund trail commissions and that from their end you don't have any choice in the matter. This doesn't mean trail commissions are totally unavoidable.

For a start, index funds and many of the best active fund managers don't pay a trail commission at all. It is perfectly possible to lead a full and happy life as a financial planner without ever recommending a product that pays a trail commission. One of the reasons why I use these products is that I feel they have been constructed with the needs of investors in mind and not those of advisers and fund managers.

As a rule, the fees of nil trail funds are significantly lower than trail commission paying funds and many of the managers are in fact better than the funds recommended by commission advisers. Only rarely will there be a fund so unique and so worthy of investment that it isn't possible to find an equal or better non-trail paying fund as a substitute. For these funds I manually rebate the trail commissions, unless the trail is so small as to make it an insignificant benefit.

If I do use a fund that pays a trail, and to do this I would need a compelling reason to do so, any trail commissions I receive will be tallied at the end of one year. These commissions will then be subtracted from the agreed review fee. If there is a surplus I will write out a cheque payable to you. I will only send one cheque per year, there is no point me sending these cheques out every month when the managers pay them because postage, administration and the costs of writing and presenting the cheque would be too large compared to the size of the rebate.

I am not able to rebate trail commissions up front because they are paid in monthly installments from the fund manager. I am not able to rebate trail commissions that I have not yet received, though am happy to rebate them in a timely manner after I do receive them.

For very large portfolios where trail commissions may be very large, rebates may be more frequent than annually.

Trail commissions for insurance and mortgage products

If insurance and mortgage products are recommended as a part of a comprehensive financial plan, any trail commission paid on these will be rebated in full to you against your review fees.

When insurance and mortgage products are recommended as a part of a limited advice plan, I generally will not automatically rebate trail commissions to you, unless they are "significant" though I may credit trail commissions received against future fees for a comprehensive financial plan, should you request one. Defining "significant" amounts of trail commissions is something I'll do on a one at a time basis, if you don't want to deal with me on an ongoing basis then I'd only be creating unnecessary difficulties for myself promising to forever send annual rebate cheques for very small amounts of money to large numbers of people. A service fee may apply in some cases.

Increasingly, insurance companies are offering the facility to rebate all commissions and premiums quoted are adjusted to take this into account. With no commissions payable quoted premiums are often reduced significantly, usually about a third - on an ongoing basis. Where possible, and this would be the majority of cases, I give nil-commission quotes so I can be paid on a fee for service basis, which has the additional benefit for me of removing the ongoing obligation of having to rebate commissions.

Trail commissions on your existing investments

If you already have some investments in place and you are paying a trail commission I can take these over and rebate the trail to you. Even if you bought the fund directly from the manager or you bought via an online discount broker, a simple letter to the fund manager is all that is required to transfer servicing rights to me.

I do this automatically for all clients, however if you do not require my advice I may be able to help you for a small annual service fee. Please contact me if you are interested.