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I’ve been writing about personal finances for over a decade and I get plenty of e-mails from people about their investment portfolios. I’m not a licensed financial adviser, but I can tell you that some of the advice that people get from their licensed advisers is shockingly bad.
Here are the most egregious examples I repeatedly see and when it might make sense to have a tough conversation with your adviser.
Commission-based compensation
If you walk into a bank branch and ask to speak to an investment adviser, chances are they are a commission-based salesperson.
Commissions can either be charged when an investment is purchased, called a front-end load, or as an ongoing fee charged for owning a fund, called a trailing commission.
A typical front-end load is 5 per cent, meaning that if you invest $100, $5 goes to the adviser, and $95 gets invested. The problem with these types of commissions is that they incentivize investment advisers to trade frequently, in a process known as account churning, to boost their fees.
Trailing commissions are paid as an ongoing fee, typically 1 per cent for Canadian equity funds. The problem with these is that they encourage an adviser to put the client into funds that pay the highest commissions, rather than the ones that perform the best for the investor.
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Actively managed funds
Most investment advisers put their clients’ money into mutual funds, which are often actively managed.
That means a fund manager is picking stocks with the goal of beating the overall market. If the adviser’s stock picking makes more money than they’re charging in fees, everyone wins, right? Too bad it doesn’t work.
In order for an active manager to deliver market-beating returns, they have to overcome two headwinds. First, they get paid through their fund’s Management Expense Ratio, or MER, which is typically 1 per cent or more. And second, active managers have to trade in and out of stocks to do their job, and that generates capital gains that will cost you money come tax time.
Passive investing, which involves simply buying and holding a few index fund ETFs, avoids both of these problems. ETFs have very low fees – 0.1 per cent or less – because there’s no fund manager to pay. And buy-and-hold investing generates no taxable events.
With these two headwinds factored in an analysis by the Wharton School of Business found a whopping 97 per cent of active managers at large and mid-sized companies failed to beat a passive index fund.
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Lack of strategy
When I started helping my parents manage their investment portfolios, I was floored by the sheer amount of funds their adviser bought for them. I counted more than 50 of them spread out over half a dozen different accounts.
And while each investment was reasonable in isolation, the problem with a portfolio like this is that they’re impossible to manage. Every investor should have a clear investment strategy, and their portfolio should be designed to implement that strategy.
That’s what I love about passive investing. It offers a built-in investment strategy, which is “I will buy and hold index funds because that offers me the easiest, lowest-risk way of tracking overall market returns.”
You then buy funds tracking the major world stock markets, such as the TSX, the S&P 500 and the MSCI EAFE Index (Europe, Australasia, Far East) and hold them in roughly equal portions. You can also add bonds to smooth the ride.
And then you wait.
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Compounding costs
The thing about investing is that performance drags of 1 per cent here and there add up over time.
Let’s use an example of someone investing $100,000 in an equity fund that grows at 8 per cent a year for 30 years.
If Investor A used a passive index fund that charged a 0.1 per cent MER, over that 30 year period their investment would grow to an impressive $978,685.
But if Investor B invested through a commission-based investment adviser that charges a 5 per cent front-load commission, a 1 per cent trailing fee, and invests in actively managed mutual funds that charge a 1 per cent MER, then over the same 30 year period that investment would grow to just $545,631.
Those fees ate up $433,054 of Investor B’s hard-earned money, which is a great deal for the adviser. For the client? Not so much.
So, who are these advisers actually working for?
Bryce Leung and Kristy Shen retired in their 30s and are authors of the bestselling book Quit Like a Millionaire.
