CHAPTER SEVEN
While many people are capable of handling their own investment portfolios (see Chapter 6), most of those same people are neither as capable, nor as interested, in handling their overall financial planning. For those who take a keen interest in personal finance (but focus mostly on investing), there is a sharp division between the camp that thinks financial advisors are a waste of time and the one that doesn’t.
For the most part, the arguments against consulting a financial advisor are to the effect that they are not sufficiently well trained, that they are commissionhungry salespeople who don’t always put their clients’ interests ahead of their own, and that investors would be better off without them to save on cost. It’s difficult to argue against those points en masse, but in spite of that, I believe most Canadians would be better off with a financial advisor. They just need to find a good one.
I have been one of the loudest proponents of the first two criticisms. It only takes a few weeks of selfstudy to pass an exam that lets you sell mutual funds to Canadians, so it’s no surprise that there are some less-than-competent financial advisors out there. There are, however, many advisors who continue to study for years and are very sharp indeed. The flaw in the way many people look at financial advisors is similar to what I pointed out at the beginning of this book. If you’re going to a financial advisor solely for investment advice, you’re doing it wrong. The value of the advice lies in its comprehensiveness.
Whether or not you want to go it alone with your financial planning, or with just your investments, is an A+ discussion. For the purposes of this book, I’m going to assume you’re not at the point yet where you have to make that choice. Most Canadians never will be. That doesn’t mean you can’t eventually shift the load over to yourself; there’s always that option if you are so inclined. But for now, I’m going to focus on what you should look for in financial advice.
(When you are ready for an A+ discussion on financial advisors, The Professional Financial Advisor III by John DeGoey is an outstanding book that I highly recommend.)
FINANCIAL PLANNING
You want a financial planner, or someone who actively offers financial planning as part of their services, as opposed to someone who only talks about investing.
But what is financial planning? Many people mistakenly believe that investing is financial planning, or vice versa. I know this from asking the uninitiated, “What do you think a financial planner does?” Very often the answer is, “I guess they help manage your investments.” Generally speaking, there are a number of areas a comprehensive financial planner will look at, of which investing is only one. These areas are:
• insurance
• monthly budgeting
• debt management
• investing
• estate planning
• education planning
• retirement planning
Education and retirement planning involve investing, but belong in their own category, because you need to develop a plan that factors in how much you’ll need for those goals, how much you have now, and how much you’ll contribute along the way.
If you are going to be working with a financial advisor, you’ll want to receive, and see samples of, a financial plan and an investment policy statement (IPS).
A Financial Plan
Creating a comprehensive financial plan is a semilaborious process, but well worth the trouble. You start with a discovery meeting where the planner essentially asks you where you are and where you want to be. The first part includes figuring out your net worth (everything you own minus everything you owe), how much you earn, how much you spend, and your attitude towards money. It should also include gathering information about the insurance you have, and what your company benefits (if any) cover, and so on.
That first meeting might also include a discussion about where you ideally want to be at various points in the future. It will detail specific goals, such as paying for a wedding, whether you want to pay for your children’s post-secondary education or not (or partially), saving up for a down payment on a house, how often you want to travel, and when you might like to retire (and what that retirement might look like).
After this discovery meeting, the planner will go away and start crunching numbers and analyzing different aspects of your finances. The planner might come back at a second meeting and provide a rough preliminary analysis that points out any holes in your current situation. Maybe you have kids, but no wills or insurance. Maybe you don’t even run a surplus with your monthly cash flow. Maybe your current investments are too risky for you. He or she will also make recommendations about what your next steps should be. Certain insurance coverage, a less risky investment portfolio, saving more for retirement, or building up a larger emergency fund, are all potential topics for discussion. Once you’ve agreed on a financial plan that addresses all your concerns (and the planner’s), you then need to execute and monitor the plan. The financial planner might be able to provide your insurance coverage, but you might get referred to a lawyer for your wills and powers of attorney.
Life happens all the time. You have another child, the stock market crashes, you have a big emergency expense, etc. Many variables affect the success of your financial planning, and a good financial planner will keep on top of them for you. Plan for an annual review, and a bigger meeting every few years, or as life circumstances dictate, and semi-regular contact over the phone or emails between meetings. You should always feel free to pick up the phone for any financial question you have, anytime.
Ideally, you’ll end up with a written financial plan (one, moreover, that you fully understand) and an investment policy statement that speaks directly to your investment portfolios.
An Investment Policy Statement (IPS)
An investment policy statement is a document that outlines what your investment portfolio should look like, and how it will be adjusted over time. It allows you to make proactive, rather than reactive, decisions. Ideally, any transactions you make after having an IPS drawn up will require no thought: you just stick to the plan laid out in the IPS.
You would never get on a plane that hadn’t settled on a destination ahead of time, so it boggles my mind to hear that so many people do not have an investment policy statement. It’s almost the same scenario. And the same is true whether you are flying commercial (using an advisor), or are a pilot yourself (DIY). Few people invest purely as a hobby: their portfolios are a means to an end. With that in mind, it would seem prudent to have some kind of plan in place. If you are travelling towards a specific destination, it helps to look out the window every now and then, to make sure you are on track.
An IPS is specific to your investment portfolio, whereas a financial plan is more broadly encompassing
(including estate planning, long-term tax planning, credit planning, cash flow, etc.). The IPS defines your tolerance for loss, what are acceptable and unacceptable investments for you, and what to do in response to different market events before they happen. It helps to take the emotional element out of investing.
Investment policy statements are similar to financial plans in that they can be simple or comprehensive. The benefit of using a financial advisor is that the good ones recognize what you need to see in order for you to be successful. For example, engineer clients tend to want a veritable tome of information that they can go through by themselves. These IPSs might include nuanced tests such as complex Monte Carlo sensitivity analyses (that can model hundreds of different sequences of portfolio returns) and can be more than 20 pages long. Present that to a non-engineer, or someone who has an aversion to graphs, and they’ll prefer going to the dentist for a root canal.
Think of it this way: an IPS should be detailed enough that if your present advisor were to retire or pass away suddenly, your new advisor could pick up right where the last one left off. It has to be simple enough that it makes sense to you. You don’t need to understand how the pilot flies the plane, but you certainly want to know if you’re travelling to your destination, and how much turbulence to expect on the flight.
HOW MUCH DOES FINANCIAL ADVICE COST?
This is one of the many areas that can really obscure the subject. There are actually a few different ways to pay for financial advice, but let’s break it down a little bit differently. You either see the fees and/or commissions you pay, or you don’t. But you always pay fees or commissions. It’s never free. Ever. Anyone who tells you otherwise should have their licence revoked.
When you don’t see a line on any statement or transaction record regarding fees or commissions, that probably means they’re built into the product. When you buy a life insurance policy, the commission can be greater than the first year’s worth of premiums you pay. If you place a $100,000 order for a mutual fund, your advisor’s firm might pocket $5,000 and give your advisor $4,000 from that, but you’ll still see $100,000 on your statement.
How does this work?
First, it’s worth pointing out that most Canadians invest in mutual funds when they start their investing career. A mutual fund is simply a turnkey portfolio that allows small investors to pool their money to get the benefits enjoyed by a large investor. Those benefits could include the ability to have a fully diversified portfolio, for example.
As a small investor, let’s suppose you have only $100 per month to contribute to a portfolio. You might know that you don’t want to hold all your eggs in one basket, and so you want to invest in different companies, different countries, some equities, some bonds, and so on. You want a diversified portfolio. With $100 per month, you can’t really diversify on your own very quickly. But if instead you buy a unit of a mutual fund, you can own a share of a larger portfolio that is fully diversified. If the mutual fund goes up 10% in value, your share also goes up 10% in value.
Let me explain exactly how mutual funds make money for financial advisors in Canada.
HOW MUTUAL FUND SALES ARE COMPENSATED
In Canada, most mutual funds pay what are known as “trailers” to firms and advisors. It is a cost that can be embedded in the management expense ratio (MER) of a fund through the service fee. While there are a handful of mutual funds that do not charge a service fee (and resulting trailers), most of them do. (Note that F-Class funds represent versions of mutual funds that have the trailers stripped out of them, so that they can be held in special fee-based accounts where the service fees are charged separately.)
For the funds that do have service fees, there may be five different versions of the same fund: front-end load, back-end load, no-load, the newer low load (sometimes referred to as “level load”), and finally the F-class versions. Let’s examine the differences by seeing how a representative sample fund can be sold under each option. Our sample fund is a Canadian equity mutual fund that has a management fee of 1.25% and other fees and expenses of 0.25% (brokerage costs, administration expenses, etc). Therefore, the mutual fund manufacturer’s fee to operate this fund is 1.50%. The manufacturer is the company that actually picks the investments and runs the portfolio.
The manufacturer also adds a service fee. It is this service fee from which commissions are generated. The typical service fee is 1.00%, with a few exceptions as noted below. To make a long story short, the MER of this fund would be 2.50%, which is made up of the management fee and other operating expenses (1.50%) plus the service fee (1.00%).
Front-End Load Mutual Funds
A front-end load version of this mutual fund pays an ongoing trailer to the advisor of the typical 1%. This means the advisor will receive 1% of the average value of your investment in this fund over the course of every year. It is called a front-end load fund because the advisor additionally has the ability to charge you a front-end sales charge of between 0% and 5%, which gets deducted from your investment immediately. In many cases, fund companies will limit this to a maximum of 2% instead of 5%. (Further, many advisors will sell a front-end version of a fund with a front-end fee of 0%. They would do this when there is no specific no-load version of the same fund available and they would like the features associated with that version of fund.)
For example, if you invested $100,000 into a front-end load fund with a front-end load of 2%, your initial investment would be docked $2,000, which goes to the advisor, leaving $98,000 to be invested. Your advisor would earn a further 1% trailer per year of the amount in your account.
DSC Funds or Back-End Load Mutual Funds
Many funds are sold on a deferred sales charge, or declining sales charge (DSC) basis. This allows for the biggest upfront commission of any of the other versions (except for the advisor who would actually charge a 5% front-end load—which is pretty rare). It is important to note that DSC funds pay your advisor an upfront commission of 5%, even though this is not subtracted from your initial investment deposit. Rather, the fund manufacturer pays the advisor in advance for the future service fees that will be generated. The ongoing trailer fee to the advisor is reduced from 1% to 0.25% in exchange for the lump-sum, upfront commission.
It is also important to note that if you sell out of these funds, you are subject to a redemption fee for the first 7 years (plus or minus depending on the fund company). The redemption fee normally starts at 5% in the first year and then gradually declines to 0% after 7 years (which explains why these funds are sometimes referred to as “declining sales charge” funds). After the 7 years, there would be no fee charged to sell out of these funds.
This redemption fee is basically the fund company’s assurance that the upfront commission to the advisor will be accounted for, should the investor sell out before the future service fees can be generated. Basically, if you sell out of your fund after year one, you pay a 5% penalty, which covers the fund company’s initial commission to the advisor.
The service fee charged by the fund remains at 1%. The service fee shouldn’t be confused with the trailer fee the advisor receives, which for DSC funds is 0.25%, as mentioned above. This means there is a 0.75% surplus the fund company is running every year and it is from this ongoing surplus that the upfront commission liability is paid off over the course of a little more than 6 years (hence, the 7-year redemption fee schedule).
If you invest $100,000 into a DSC fund, your advisor generates a $5,000 commission right away, and you still have $100,000 invested. The advisor additionally receives an ongoing trailer fee of 0.25% of the average value of your investment every year. If you sell out of your funds within the first 7 years, you are charged a redemption fee, which goes to the fund company to offset its upfront payment to the advisor.
Essentially, you are making a promise that you will stay invested for 7 years—or pay a penalty. Because the fund company has this guarantee from you, they can afford to pay a large lump sum to the advisor right away.
No-Load Funds
No-load funds have neither an initial front-end fee nor a DSC fee. In other words, you only have to worry about paying the ongoing MER for as long as you hold the fund. The advisor will generate a 1% commission every year based on the average value of your investment. They receive no upfront commission for no-load funds, just the ongoing trailer fee.
If you invest $100,000 in a no-load fund, you will have nothing deducted from your initial investment and your advisor will not earn an upfront commission, but they will still earn a 1% commission based on the average value of your investment every year. (In some very rare cases, a no-load fund may have a higher trailer than other versions of the same fund—which means it would have a higher service fee as well.)
Low-Load Funds
Just think of low-load (or level-load) funds as a scaledback version of DSC funds, with a bit of a twist. The upfront commission is lower, averaging 3% versus the DSC’s 5%. The redemption fees start at 3% and decline to 0% after 3 years, instead of the fees starting at 5% and declining to 0% after 7 years for DSC funds. But here is the twist: while the trailer fee is initially set to 0.25%, it increases to 1% as the redemption fee schedule expires. This is why it is also known as a “level-load” fund.
If you invest $100,000 into a low-load (or level-load) fund, you are not docked any money upfront. Your advisor receives $3,000 as an upfront commission and 0.25% of the average value of your account in the first year. He or she might receive 0.5% of the average value of your account in the second year, 0.75% in the third year, and then 1% every year thereafter.
F-Class Funds
The “F” stands for “fee” in fee-based account funds. These are a relatively new type of account, which charge clients a transparent fee that is easily seen on statements (where it’s likely to be listed as the “client advisory fee”). This was introduced to address complaints made by investors who weren’t sure what they were paying their advisors, because the compensation was essentially hidden or, at best, not transparently disclosed. For the F-class version of a fund there is no service fee. So, for our sample fund, that would mean that the MER has been reduced from the 2.50% in all the previous cases to 1.50%. But to make an apples-to-apples comparison, you need to add the client advisory fee to the MER to determine your all-in cost. While a fee-based account provides more transparency, it may not necessarily be cheaper. Typically, the client advisory fee for F-class funds is set to 1%: it is exactly the same as a no-load fund in terms of cost and flexibility (i.e., no charges to buy and sell), although a bit more transparent.
There is one important advantage of fee-based accounts for non-registered investment portfolios in that it is possible to claim the client advisory fee as a tax deduction on your tax return (you need to have your accountant verify this for your own situation to be sure). In this case, if your marginal tax rate was
40%, then the after-tax client advisory fee would be effectively 0.60% instead of 1%, meaning your out-of-pocket costs for an F-class version of a fund in a non-registered account would be 2.10% versus 2.50% for all the other fund versions.
If you invest $100,000 in an F-class mutual fund, your initial investment is not docked any upfront charge, and your advisor would not receive any upfront commission. The advisor would receive a percentage (typically 1%) of the average value of your account every year. There would be no cost to sell out of the F-class fund. For non-registered accounts, your client advisory fee may be tax-deductible (check with your accountant).
A final note: all the commissions noted here may not necessarily go to the advisor, but may instead be split between the advisor and the advisor’s firm. Depending on the situation, the advisor normally receives between 40% and 80% of the commissions generated, although percentages below and above this range are also possible in certain situations.
DIFFERENT FEE MODELS
There are a number of pricing models for financial advice. Here are the major ones:
1. salary plus bonus
2. commission
3. fee-based
4. fee-for-service
5. a mix of models
You’ll find salary-plus-bonus advisors at bank branches, for the most part. But the most prevalent model today is commission-based financial advice. These financial advisors earn a commission based on the type of product they sell you, whether it’s mutual funds, stocks, insurance, or bonds. In the case of mutual fund sales, I’ve heard some people say they don’t pay for advice. While they don’t see a bill, they pay in the form of more expensive products, which have the cost of advice built into the product itself. If an advisor ever tells you that it doesn’t cost you anything, run away as fast as you can. They are flat-out lying. They may rehearse a song-and-dance routine for your benefit about how someone else pays them, and it might sound convincing. But it’s all smoke and mirrors.
Fee-based (for asset-based) advice is a growing trend in the industry. The fee is based on a percentage of your portfolio’s value and is clearly shown on your financial statements. This model tries to separate the cost of advice from the cost of the product. You still pay, and it may not be cheaper, but it is more transparent.
A fee-for-service financial advisor might bill you strictly by the hour, or by using a flat rate per project. They might charge $3,000 plus tax for a financial plan, for example. You might be free to buy the products on your own to implement the plan at self-serve costs and then head back for an annual review, for which you would also pay a fee. That $3,000 bill might be steep for a young client, but it could be a bargain when your portfolio is $1 million. A commission-based mutual fund sales representative might be costing you $10,000 per year in financial advice fees that are embedded in the products they’ve sold you.
Suffice it to say, it’s a tricky discussion, considering you have to weigh various factors: the model of compensation, the size of your portfolio, and how much help you require. But don’t over-think it (at least, not yet).
Here’s what you need to know for now. No one works for free, and few people begrudge others for trying to earn an honest living. One of the first conversations to have with any prospective financial advisor is about the compensation they charge. Ask them exactly how they get paid, what conflicts of interest that exposes them to, and how their fee model compares to other models, and then shut up. Let them do all the talking. If they squirm, or are purposefully vague, tell them you don’t expect them to work for free, and that they should just be candid. If they still seem shifty, run, don’t walk, to another financial advisor.
I’ve found that one of the best determinants of a successful financial advisor is candour. Conflicts of interest are ubiquitous in life. The mere existence of a conflict of interest does not mean that advisors, or anyone else for that matter, are incapable of rising above them. But we have to recognize their existence, and recognize that there are some bad apples that really spoil the bunch.
When dealing with commissioned financial advisors, you have to understand that there is a strong correlation between how much they earn and how big your portfolio is. There is also a strong correlation between their experience and how big your portfolio is. That means that a larger percentage of experienced advisors might not take on a client with a small portfolio. Having said all this, you don’t really need a comprehensive financial plan when you’re just starting out.
The Five Rules are your plan for the time being. Once you’ve paid down all your high-interest debt, then you can start thinking about investing. (See Chapter 6 for a how-to guide.) When you are paying 28% interest on credit card debt, it doesn’t make sense to invest when you would be lucky to see your money grow at even one-quarter of that rate.
When you first become an investor, the amount you invest is far more important than the makeup of your portfolio in determining how fast your portfolio grows. Remember the example from the introduction to this book? Two hundred dollars per month at 1.5% annual growth will give you almost $26,000 in 10 years. Put aside only $100 per month and to get the same portfolio value after 10 years you’ll need more than 14% annual growth in your portfolio. How you set up your investments when you have a large portfolio is phenomenally important. How you set up your investments when you have a small portfolio is phenomenally unimportant. How much you contribute is what you need to focus on at first.
HOW TO PICK A FINANCIAL ADVISOR
Before you get too invested in a particular consultant, it pays to see if he or she is even registered as a financial advisor. Here are a number of steps you should take:
1. Check to see if they are registered as a financial advisor with the Canadian Securities Administrators through their National Registrant Search: www.securities-administrators.ca/nrs/nrsearch.aspx?id=850
2. If the advisor is not listed there, check with your provincial securities commission. Sometimes the information is not listed in both places. You can call your securities commission and tell them you would like assistance confirming the registration of a financial advisor you are considering or are already doing business with.
• Alberta Securities Commission: 1-877-355-4488
• British Columbia Securities Commission: 1-800-373-6393
• Manitoba Securities Commission: 1-800-655-5244 (Toll-free within Manitoba only) or (204) 945-2548
• New Brunswick Securities Commission: 1-866-933-2222 (Toll-free within New Brunswick only) or (506) 658-3060
• Securities Commission of Newfoundland and Labrador: (709) 729-4189
• Northwest Territories Department of Justice: 1-867-920-3318
• Nova Scotia Securities Commission: (902) 424-2499
• Nunavut Registrar of Securities: (867) 975-6190
• Ontario Securities Commission: 1-877-785-1555
• Prince Edward Island Securities Office (PEISO), Office of the Attorney General: (902) 368-6288
• Quebec (Autorité des Marchés Financiers): 1-877-525-0337
• Saskatchewan Financial Services Commission: (306) 787-5645
• Yukon Securities Office: (867) 667-5466
3. It’s possible the advisor you are considering is not licensed as a financial advisor, but rather as an insurance agent. Check with your provincial regulator that handles life insurance agent registration.
• Alberta Insurance Council: (403) 233-2929 or (780) 421-4148
• Insurance Council of British Columbia: 1-877-688-0321
• Manitoba Insurance Council: (204) 988-6800
• New Brunswick, Department of Justice, Insurance Branch: (506) 453-2541
• Newfoundland and Labrador: Try calling (709) 729-2595
• Northwest Territories: (867) 920-8056
• Nova Scotia, Office of the Superintendent of Insurance: (902) 424-5528
• Nunavut, Superintendent: 1-867-873-7308
• Financial Services Commission of Ontario: 1-800-668-0128
• Prince Edward Island: 902-368-4937
• Quebec, Autorité des Marchés Financiers: 1-877-525-0337
• Insurance Councils of Saskatchewan: (306) 347-0862
• Yukon: (867) 667-5940
4. You can also check to see if there have been any disciplinary actions taken against them:
• www.iiroc.ca/English/Investors/MembInfoService/Disciplinary
Search/Pages/default.aspx
• www.mfda.ca/enforcement/hearingscurrent.html
• www.mfda.ca/enforcement/hearingscomplete.html
• www.mfda.ca/enforcement/hearingSchedule.html
Check all four.
5. Google them to see what you dig up.
6. Ask them the following questions:
• Are you a full-time financial advisor?
• How do you get paid?
• Do you use investment products manufactured by your own firm?
• How long have you been an advisor?
• Do you have a CFA, CFP, FCSI, or other relevant designation?
• Do you also sell life insurance?
• Do you have a sample investment policy statement I can look at?
• Do you have a sample financial plan I can look at?
• How many people are on your team?
• How often will we meet?
7. If they say they are a certified financial planner, you can also check their registration with the CFP licensing authority in Canada, Financial Planning Standards Council (FPSC), by calling 1-800-305-9886.
The specific answers you get are not as important as the advisor’s demeanour. You should meet three or more different advisors before you decide on one to undertake your comprehensive financial plan. Keep in mind, if you are just starting out, generally you’re going to end up with someone who might not tick off all the boxes, so to speak. But as your portfolio grows, your pickiness can grow too.
ADVISORS AND LIFE STAGES
Do you need a financial advisor when you are just starting out with your first investment portfolio? Or should you wait until you have achieved a certain asset level before working with a professional? These are somewhat leading questions that don’t actually address the real question, which is, do you know what you don’t know about managing personal finance?
Personal finance is about more than just rates of return, MERs, and diversification. These terms are meaningless if you haven’t even made up your mind to start saving, because if you don’t have a surplus, you’ve got nothing to invest. You can read Benjamin Graham and David Dodd’s book, Security Analysis, until you’ve got it memorized, but without any skin in the game, it is all academic.
Perhaps the first thing a financial advisor will tell you is that you should stop your automatic contributions to a mutual fund portfolio and pay off your high-interest credit cards. Or perhaps you have five kids and no wills or powers of attorney: you know that’s wrong, but you just need a gentle push to actually do something about it. A financial advisor may give you that push.
While there are some advisors who care only about your actual investment portfolio, they might be the ones who tend to work with very large portfolios (many millions of dollars) and with clients who have multiple advisors for different aspects of their financial affairs. But more and more, the average advisor provides advice, or access to advice, on all aspects of your financial situation.
Perhaps the question you really don’t know you should be asking is whether you should change financial advisors over time based on your stage of life. One possible answer that may surprise you is: perhaps not, because they will change for you.
A change of advisors may come about for one of two main reasons. First, advisors are required continually to upgrade their education in order to maintain their registrations and designations. Products and legislation evolve all the time, and advisors are responsible for keeping up to date with both. They also gain experience as time goes on, obviously. Second, advisors may change firms or their type of registration. There are various reasons for this. Some firms’ product platforms or planning support are better suited for certain advisors and their particular practice or philosophy. We’re scratching the surface here, but suffice it to say, the advisor you started your investing career with can evolve as your portfolio and planning requirements evolve.
So if you’re wondering when you should be looking for your first financial advisor, generally speaking, the average Canadian needs to start looking when they start dealing with money. Don’t be shy about not having enough assets. Some advisors do have client minimums, but they’ll often point you in the right direction based on your life-stage if you’re not the right fit now.
DOES THE SIZE OF YOUR FINANCIAL PLAN MATTER?
It’s not the size that matters: it’s how you use it. I’m talking about financial plans. Everybody should have one, but one size does not fit all. That’s true whether you are a DIY investor or are using a full-service advisor.
As the financial-advice industry continues to evolve, more and more advisors are offering comprehensive financial planning as part of their value proposition. Whether they have the CFP designation or not, many will have access to internal financial planning support teams, and some will even hire paraplanners to prepare the financial plans on their behalf. Sometimes these plans can be more than 50 pages long. So should you feel like you’re missing out if your plan is lacking in girth? Not necessarily.
If you are new to the workforce, what could you possibly expect to see in your financial plan that requires a document so long that the better part of a forest has to be sacrificed in its production? Unless you inherit a complex estate when you are young, more than likely you have all the same problems as everyone else: student debt, saving up for a mortgage, monthly budgeting, starting an investment plan, and getting the right type and amount of insurance to disaster-proof your life.
A plan written for a retirement date 40 years from now makes a lot of assumptions, many of which will turn out to be false, simply because no one knows what the future holds. Most people don’t know ahead of time exactly how many children they will have—or even the number of their spouses.
When you’re young, really, you just need to focus on putting away as much as you can, investing prudently, getting your debt under control, and hoping like mad that the stars align to allow you to retire earlier than you hoped. Retirement is so far off at this point that you’ll have no idea what to expect, which means your buy-in to a 50-page plan is likely to be minimal. Many younger investors are better off with a plan that simply helps get them into good long-term habits while focusing on the shorter-term goals.
Fast-forward and, with diligence and luck, those habits will translate into an estate that needs an expert’s advice. The range of possible outcomes to your life has narrowed and, as retirement approaches, it becomes much more top-of-mind. Your financial plan becomes more detailed, and hence thicker over time.
For DIY investors, the same thought process holds. You may have some rules to live by when you’re starting out, but as time goes on you’ll want to formalize your plan on paper. Especially as there is no guarantee you will outlive your spouse. That may be a case where size really does matter.
ARE YOU GETTING THE RUNAROUND?
Just because you hire an advisor to provide advice doesn’t mean they are always right. Most people understand that recommendations are just that: recommendations. But when the advisor flat-out ignores you, you know you’ve got a big problem. So when I heard that good friends of mine were getting the runaround from their financial advisor and his company, my blood started to boil.
My friend, the investor, held shares of Nortel and was nervous about continuing to hold them. He asked his advisor to sell the shares if they fell below $34 in price. Although they fell in price, no shares were sold. The investor noticed the price had dropped below his target sell price while watching TV with his wife, who was in the hospital being treated for cancer. He didn’t call his advisor immediately; he had other things on his mind.
He didn’t find out until later that the shares were never sold. Naturally, he was upset and asked his advisor for an explanation. The advisor acknowledged the mistake, but persuaded the investor to hang on because analysts expected Nortel’s share price to rise again. The investor reluctantly agreed, but with the stipulation that if the shares continued to fall and hit $30, they would be sold.
To make a long story short, the advisor never sold the shares. Nortel stock kept falling and the investor kept getting the runaround. For years. When the investor told me of these troubles, I suggested that he immediately make a complaint. I explained that the advisor’s inaction constituted negligence.
Time passed but the firm did not conduct an investigation. Because there were no notes on file about my friend’s instructions regarding Nortel, and because the advisor had now changed his story and denied ever having discussed selling the stock, the firm sided with the advisor. The investor never heard from the advisor again and the branch manager was assigned to take over the account.
My friend is following up through a second-stage complaint procedure with the Ombudsman for Banking Services and Investments (OBSI), but even if they rule in his favour, there is some question as to whether or not the decision would have any impact. The case is difficult to assess because there was no transaction (which is the point) and there are no notes about either selling or holding Nortel in the advisor’s client file. So it has become a he-said-she-said situation.
Financial advisors are supposed to document every material discussion they have with an investor. Usually they are urged to do so from internal compliance officers who want to make sure that when, not if, they eventually get a complaint, there is documentation to support the actions that were taken. If disputes are investigated, one of the things looked at is the consistency of the advisor’s notes. Some are more scrupulous than others about documenting their actions, and the ones who regularly attach notes to client files in a timely manner are going to stand a better chance under scrutiny than the ones who don’t.
But there is something investors can do to help their cause: they can make their own notes. The Canadian Securities Administrators provide a handy worksheet1 you can download for free to help you make notes on any conversation you have had with your advisor. You should note any material discussions you have, and date and store them with your other records. Investor disputes are tough cases to win in Canada, but with lots of money on the line, it pays to take the time to make your own notes. It may not make the fight more even, but it’s certainly better than doing nothing.
You hire an advisor to give you advice, but it’s ultimately you who makes the decisions. Not the advisor.
A MONEY COACH INSTEAD OF A FINANCIAL ADVISOR
One of the Catch-22s of the financial-advice industry in Canada is that sometimes you find motivated individuals who desperately want to work with a financial advisor, but it might not make sense from a revenue perspective for that advisor to take them on as a client. A money coach might be worth considering for people in this situation.
Not all, but many financial advisors set minimum asset requirements for prospective clients. Don’t have $1 million? Go see someone else. Some advisor teams have asset minimums of $10 million or more, and some set the bar as low as $50,000. There are also those who have no minimum at all. As you can imagine, because the bulk of advisors’ revenues is closely tied to the assets they manage, there is a trade-off between the number of their clients and the amount of work they perform for each one.
If you have a large estate, you are going to gravitate towards an advisory team that specializes in larger estates. They will have fewer clients but should, in theory, be spending more time crafting a plan for your more complex situation. If you are just starting out, you might find yourself working with an advisor who handles many more clients but their investment policy statements and financial plans are much less onerous. So they can meet your needs, as well as the needs of hundreds of other people in a similar situation.
I haven’t performed any double-blind studies to the effect, but based on what I’ve seen in the industry, advisory team experience and knowledge are pretty strongly correlated with the portfolio size of their average client. In other words, the more money you have, the better advisor you might have access to. Nothing earth-shattering about that. Rightly or wrongly, however, the desire to work with tested advisors leads many people to avoid newer advisors who are precisely the ones most likely to take them on as clients.
One solution to this conundrum is the idea of working with a money coach, that is, someone who coaches you on money decisions. I liken it to personal finance therapy.
You know by now that I believe that basic personal financial success boils down to the Five Rules (see Part 1). It’s not rocket science, and yet many people have difficulty with some of these ideas. In fact, before you can work with a financial advisor who will handle your assets and create a detailed financial plan, you first have to generate those assets. And, generally there won’t be significant assets unless you’ve got at least a partial handle on most of the core competencies described in my rules. This is where a money coach may be just the ticket.
They generally work on a flat fee or hourly basis. Most get no compensation for recommending particular products. You can expect a range between $1,000 and $2,000 for a basic coaching package.
I’ve heard of some financial advisors who send their clients to money coaches—a testament to how the work they perform is different from the services offered by a traditional financial advisor. Many financial advisors offer money coaching as part of their service offering too, so make sure to ask your advisor about it. In the future, I can see financial advisors and money coaches working in tandem as they can perform very different functions—both of which can be integral to your long-term financial success.
1 Google: “When your broker calls, take notes,” and select the Canadian link for the PDF file.