Is Your Car Taking You To Your Retirement Dreams?

When a mechanic is fixing your car, it’s probably a good idea for that mechanic to have as many tools he can. Your car is a complex system with many moving parts that, when working properly, takes you to your destination.

When you and your advisor are putting together your financial tools to reach your retirement destination, it’s also a good idea to have as many tools working for you to give you the best chance to reach your goal.

With conventional investments, the structure of the tools is fairly uniform… mutual funds.

In the Exempt Market, the structure of the tools varies, which in a lot of ways provides a complementary relationship for the overall tool kit. Here are a few tools to help the drive to your retirement destination be as smooth as possible…

Mortgage Investment Corporations (MICs) are investment structures that collect money from investors and then lends that money out in the form of mortgages. These investments are generally lower risk with the protection of the capital coming from the collateral. Unfortunately, these investments pay dividends that are taxed as interest income, so it will take the full brunt from Revenue Canada.

Flow Through Shares are special type of share that allows certain expenses to “flow through” to the end investor. Companies in the mining, oil and gas industries will use these structures to obtain capital to fund their operations. The strongest elements of these types of investments are their tax effectiveness. One of the best ways to minimize your tax bill is utilizing flow through shares.

Real Estate Income Trusts (REITs) are a way to participate in real estate, without having to collect late rent cheques or clean toilets. The good manager of the REIT will manage the asset while ensuring that it is in good order and revenue is coming in on a consistent basis.

Private Equity allows investors to be part of the ownership of an operating company through structures such as preferred shares or limited partnership units. Companies who are looking for growth capital, finance assets or to buy out competitors will often come to the Exempt Market to fund their initiatives.

These are just a few types of investment tools in the Exempt Market. Future articles will include more types and the benefits associated with them.

 

Marty Gunderson is a self proclaimed Exempt Market geek. He has served in a variety of leadership positions in the industry, from sales to issuer to dealer. He is the founder of www.BetterReturns.ca, a site that highlights a few quality exempt market offerings.  To contact Marty, please email marty (at) idealeader.ca

Taxation and Financial Planning – Part 1 of 2

A topic we all love to hate – but it needs to be examined a bit closer when it comes financial and insurance/estate planning – but no, I am not going to turn this into an course on Income Tax – but rather I am going to present some points for consideration in your planning processes.

I am always amused at various federal and provincial politicians that stand up and brag that “we have removed the burden of taxation from those Canadians with the lowest incomes”. Sounds wonderful and some politicos may actually believe it – but I assure you it is completely false. Other tax goodies such GST/HST tax credits for low income earners, Climate Action credits, planned low income tax credits, etc. are simply political smoke and mirrors. I will clarify something right here – I never have been, am not and never expect to be a member of any federal, provincial or civic/municipal political party or action committee – my comments are completely apolitical. I lump all political parties together when it comes to these games, and frankly I don’t trust any of them to be completely honest – but then I am a cynic or so I have been told!

OK, back to my point – sort of. Every person in Canada who purchases anything is paying taxes to all levels of government in Canada plus additional taxes to foreign governments if the item(s) purchased were made outside Canada or the raw materials came from outside Canada. And this applies to EVERYONE – from the person at the top of Canada’s Wealthiest list to the person who scrapes by begging for handouts or receives social assistance of one type or another. Charities pay taxes too – and this includes religious organisations that, for whatever reason, have been given charitable status – money is being moved around to all levels of government.

Many people “rejoice” when tax-freedom day arrives – somewhere around the middle of the year according to several organisations – I contend this is a complete fallacy – and I’ll tell you why!

Assume I make and sell a widget. When I calculate the price for which I am willing to sell it, I have to look at all the TAX inputs – buying the raw material to make it – I am paying taxes to the seller of the raw materials who is paying taxes on those raw materials to government in the form of royalties, licence fees plus taxes on purchasing the equipment that they used to get the raw materials. I have to calculate in the selling price the amount of money I paid to the manufacturers of the equipment that I use to make my widget and they have included in their price of the equipment all of the taxes they had to pay. I have to calculate the labour costs included in each widget I make and that includes payroll taxes such as CPP, EI, Health Care etc.

Then I have to include the property tax I pay for the building that houses the equipment in which I make the widget – and if I lease the building and land, then I pay a pro-rata share of the taxes my landlord pays. Next I have to package the widget and pay taxes on the materials used in the packaging, then I have to ship it somewhere and pay taxes on that including road and bridge tolls, provincial, federal and local taxes or surcharges, fuel taxes, port taxes, customs duties etc. Finally I get around to paying me – and I have to figure in my tax bill to figure what I need to have left to take of me and my family and pay all of these same types of taxes on everything we consume or use.

Whether people want to recognise it or not, wealthy people do pay more total taxes than lower income earners – they like more toys, more vacations, more luxuries – guess what – there are taxes included in all of those items too – but then, to admit that would go against the current 1% versus the 99% protests! The simple fact is, there is no “tax freedom” day – everything we spend goes for taxes or raw materials – everything in between is taxes or becomes taxes in one form or another – but let’s not get depressed about it! How does this impact on financial and insurance/estate planning?

Stay tuned for Part 2 next week!

How Do You Spell Exempt?

 

 

Based on the number of comments from the previous post, I gather there are more than a few people who do not know what the exempt market is.  I’m not overly surprised, given the lack of marketing there is, relative to the conventional investment market.

There are three key elements of the exempt market that makes it unique.

 

 

What’s in a name?

The industry is aptly, but awkwardly, named exempt market because investments offered here are “exempt” from prospectus. You may recognize prospectuses. It’s the forest you receive in the form of a simplified prospectus, when you buy a Canadian mutual fund. These documents, which seem to be getting thicker and thinker, are filed and reviewed by the pertinent securities commissions.

The exempt market space has its own disclosure documents, albeit contributing less to forestry stock valuations. Documents such as offering memorandums outline applicable risks as well as terms and conditions of investing.

Restricted Entry

Unlike GICs and mutual funds, only certain people or companies can purchase exempt market securities. Who are these special people?  Well that generally depends on where you live and your financial situation. Rules using limitations such as eligible investor and accredited investor are examples of who can purchase the investments.

Where’s the exempt market store?

Until recently, there wasn’t really any formal national distribution of exempt market products. The club of securities regulators decided to harmonize the rules and created the exempt market dealer.

In the same way that mutual fund dealers sell mutual funds, the exempt market dealer offers… you guessed it… exempt market securities. These highly regulated dealers ensure their representatives are dispensing appropriate suitability advice. The dealers also have liquidity and bonding requirements to ensure they are financially stable.

You’ve probably noticed that these points don’t necessary talk about the investments themselves. That’s the exciting thing about the industry; there are a wide variety of investments offered here. In the coming articles, I’ll try to address a few of them.

Still confused?  No worries.  Here’s a video I did explaining it.  Hope it helps.

 

Marty Gunderson is a self proclaimed Exempt Market geek. He has served in a variety of positions in the industry, from sales to issuer to dealer. He is the founder of www.BetterReturns.ca, a site that highlights a few quality exempt market offerings.

 

 

 

 

 

 

 

Effects of Inflation on Financial, Estate and Retirement Planning and product illustrations

After reviewing different options for growth rate assumptions in previous blogs, let’s now examine inflation. From Statistics Canada’s website, the following inflation rates apply for the same 1992 to 2011 period.

1992 1.8 %
1993 1.4 %
1994 0.2 %
1995 1.5 %
1996 1.9 %
1997 0.7 %
1998 0.9 %
1999 2.4 %
2000 3.0 %
2001 0.7 %
2002 3.7 %
2003 2.1 %
2004 2.2 %
2005 2.2 %
2006 1.8 %
2007 2.6 %
2008 1.3 %
2009 1.5 %
2010 2.7 %
2011 2.7 %

Average 1.87 %

Median 1.85 %

CAGR 1.86 %

Inflation has ranged considerably since the 1950s – from mid-double digits (during the period of a strange PET creation called the Anti-inflation Board) to a minus during a recession. Even in this illustrative period it has gone from 0.2% for a low to a high of 3.7% – more than 18 times the lowest rate!! 3.7% is a plan killer – particularly over 20 or 30 years – and remember from a couple of blogs back, this is just the main CPI result – sub-indices for things such as Health Care and Recreation can be and very often are considerably higher – which results in an even larger impact post-retirement than just the basic CPI. But let’s continue the basic thread here.

If I take the Average, Median and CAGR results from one of the previous blogs and subtract these inflation figures, look at what happens.

Net Average 4.98 % $2,640.69 Overstated by 32.20 %

Net Median 8.00 % $4,660.96 Overstated by 133.34 %

Net CAGR 3.52 % $1,997.49

You can see that the Net Average drops from 6.84% to 4.98%; the Net median is reduced from 9.85% to 8.0% and CAGR drops to 3.52% from 5.38%. Putting these inflation-adjusted rates into the usual future-value formula, using the Net Average rate results in the initial $1,000.00 invested growing to $2,640.69, the Net Median gives $4,660.96 while using the Net CAGR provides a total of $1,997.49 after the 20-year period. I will further complicate this discussion by taking the CAGR from the blog adding money to the fund – 5.01% and subtract the 1.86% CAGR for inflation, and now I get a Net CAGR of only 3.15%!!

I am going to ignore the Median calculations in my future comments – and you can obviously see why – that leaves either the Net Average or the Net CAGR.

The CAGR is the actual calculated Compound Annual Growth Rate for the initial $1,000.00 investment over 20 years – it takes into account the actual up and down movements for each year to give the actual end result. The numerical Average does not consider the actual end result of the annual changes to the rates of return – rather just the annual rates themselves. Which, IMHO, is seriously flawed logic. As you can see from the table above, using the Net Average results in projected future values 32.20% HIGHER than actual history would indicate – can you justify an error rate this large to yourself or your clients??

I cannot.

I was told by a statistician many years ago that averages are nothing but the worst of the best and the best of the worst – reviewing these numbers proves that statement to me – and I hope to my readers as well.

Talking to various actuaries (a very interesting group of folks I might add) over many years, particularly pension actuaries, I have been told many times that the real rate of return on money over long periods of time (30 plus years), is typically in the 3.00% to 3.50% range – RROR being return over and above inflation but before taxes – and surprise, surprise, this is what is supported by the actual results over the previous 20 years using the S&P/TSX Total Return Index and applying the Stats Canada CPI and actual calculated Compound Annual Growth Rate!

Next time, I will discuss another favourite hobby-horse – income taxes! Cheers

Life After Mutual Funds?

 

Ahhh, the 90’s!

It was the days of MC Hammer, Nelson Mandela and “Irrational Exuberance”. It was also the time that an obscure, little known type of investment called a mutual fund started to become a household name. With the interest rates hovering at historic lows, many “GIC refugees” started flooding in to these investments that promised higher returns. The amount of money that went into the mutual fund industry was staggering.

That was 20 years ago. Clearly things have changed… music, locations of sports teams, and my waistline. But there’s one thing that hasn’t changed, Canadian’s infatuation with mutual funds. Have mutual funds deserved all the love we’ve given them? Well, that’s for you to decide, but many people question the long-term performance of their mutual funds.

Maybe that’s part of our identity as Canadians. We all have mutual funds but wonder WHY we have mutual funds.

Let’s fast-forward to today and we find another burgeoning financial phenomenon. Enter the Exempt Market. Now just to be clear, the exempt market is NOT a specific product like a mutual fund. It’s actually named for HOW the products are purchased. Just like mutual funds, which are sold through a mutual fund dealer, these exempt or private investments are purchased through an exempt market dealer. Some more popular investment structures in the exempt market are real estate investment trusts, flow through shares, mortgage investment corporations and limited partnerships.

It’s understandable that you may not have heard of the exempt market, given the distribution of these products only formalized into the exempt market within the last 3 years. Before that, outside of Ontario, there were really no registered dealers who were approved by the securities regulators. Ontario had Limited Market Dealers until the forced transition to an exempt market dealership required by the National Instrument 31-103.

Just how popular is the exempt market? Well, it’s growing and growing fast. Last year, the people placed about $140 Billion into the exempt market, as reported by the EMDA. To put that in perspective, in the same period, net sales of mutual funds was about $21.2 Billion, as reported by IFIC.

In the coming weeks, I’ll write about the exempt market as it relates to raising capital for businesses as well as participating in unconventional investments for qualified investors.

 

Marty Gunderson is a self proclaimed Exempt Market geek.  He has served in a variety of leadership positions in the industry, from sales to issuer to dealer.  He is the founder of www.BetterReturns.ca, a site that highlights a few quality exempt market offerings.  Contact him at marty (at) idealeader.ca

Average returns versus CAGR for withdrawal plans

So here we are again, but this time we will look at the difference between Average rate and the calculated CAGR when there is a WITHDRAWAL plan in place. So again, same rate history and sequence as we have been using for the past several examples but now we start with $1,000.00 and withdraw $50.00 each year – as you can see the average is still 6.84% but the calculated CAGR required to get the same result after 20 years is now 6.14%. If you use the average rate of 6.84%, then the final result is HIGHER by $293.79 or 22%. In this specific case, the use of the average rate produces what APPEARS to be a better result for the client – but it isn’t in terms of the reality – the figures appear better, but the actual results prevail of course! If the sequence of returns is reversed, then the resulting capital is ONLY $577.92 – and the calculated CAGR is now way down to 3.73% – interesting to say the least!

Sequence of returns is absolutely critical for withdrawal programs as you can easily see. Using average rates is just unforgiveable and indefensible IMHO!

Year Rate————$1,000.00
1992. . . .7.8 %__________$1,024.10
1993. . . .-4.6 %__________$ 929.29
1994. . . .29.0 %__________$1,134.29
1995. . . .-2.5 %__________$1,057.18
1996. . . .11.9 %__________$1,127.03
1997. . . .25.7 %__________$1,353.83
1998. . . .13.0 %__________$1,473.33
1999. . . . -3.2 %__________$1,377.78
2000. . . .19.7 %__________$1,589.36
2001. . . . 6.2 %__________$1,634.80
2002. . . .-13.9 %__________$1,364.51
2003. . . .-14.0 %__________$1,130.48
2004. . . . 24.3 %__________$1,343.03
2005. . . . 12.5 %__________$1,454.66
2006. . . .21.9 %__________$1,712.28
2007. . . .14.5 %__________$1,903.31
2008. . . . 7.2 %__________$1,986.75
2009. . . -35.0 %__________$1,258.89
2010. . . .30.7 %__________$1,580.02
2011. . . -14.4 %__________$1,309.70

Average. . .6.84 % $1,603.49

CAGR. . . . 6.14 % $1,309.70

So all of this is interesting to look at and consider, but next I am going to throw inflation into the issue and finally, some comments on taxation! So this is nice and short – if anyone wants to see a printout of the other tables showing the reversed sequence and the CAGRs, just email me! Cheers

What happens to Average and CAGR when deposits are made every year?

So let’s go back and do the next problem in looking at averages and CAGR – as noted previously, I am going to ignore Median results as they are completely without any justifiable foundation. So here we have the same rates and sequence of returns with the only difference being the addition of $50.00 to the fund each year. As you would expect, the end result in terms of dollars is higher – no surprise.

However, check out the CAGR – IT HAS DROPPED from the 5.38% in the previous blog! Why – because there is an ever increasing amount of capital and the compounding effect of the ups and downs – particularly the downs, result in a lower overall calculated Compound Annual Rate of Growth – something that most people do not expect.

Year Rate . . . . . . .$1,000.00
1992 . . .7.8 % . . . . . .$1,131.90
1993 . . -4.6 % . . . . . .$1,127.53
1994 . . 29.0 % . . . . . .$1,519.02
1995 . . -2.5 % . . . . . .$1,529.79
1996 . .11.9 % . . . . . .$1,767.79
1997 . .25.7 % . . . . . .$2,284.96
1998 . .13.0 % . . . . . .$2,638.50
1999 . . -3.2 % . . . . . .$2,602.47
2000 . .19.7 % . . . . . .$3,175.01
2001 . . .6.2 % . . . . . .$3,424.96
2002 . .-13.9 % . . . . . .$2,991.94
2003 . .-14.0 % . . . . . .$2,616.07
2004 . . 24.3 % . . . . . .$3,313.92
2005 . . 12.5 % . . . . . .$3,784.41
2006 . . 21.9 % . . . . . .$4,674.15
2007 . . 14.5 % . . . . . .$5,409.15
2008 . . .7.2 % . . . . . .$5,852.21
2009 . .-35.0 % . . . . . .$3,836.44
2010 . . 30.7 % . . . . . .$5,079.57
2011 . .-14.4 % . . . . . .$4,390.91

Average . . .6.84 % . . . . . .$5,907.68

CAGR . . . . 5.01 % . . . . . .$4,390.91

As you can see the difference between the AVERAGE growth rate and the CAGR has now WIDENED to 1.83% – it may not seem like a lot, but in real dollar terms it is! If you re-run this table and substitute the Average Growth Rate of 6.84%, the resulting value after 20 years is $5,907.68 – a difference of $1,516.77 – or an increase of 33.5% over the actual value using the CAGR or the variable growth rates from the table. What a horrendous error rate!!

How can a potential error rate of this magnitude be justified in any financial plan – retirement, estate or any other component?? All I can suggest is that if you are going to use average rates, you will need plenty of E & O coverage within the next few years!

I am going to presume that readers are now satisfied with my statement that using historical average rates for forward-looking assumptions is a fools game – but remember, this discussion isn’t over as we have to examine the impact of inflation and then taxes – then to complicate matters I am going to compare the sequencing of returns during the both the accumulation phase and the withdrawal or decumulation phase of financial plans. More fun and games with numbers – I am going to stay with the same assumed growth rates in this table – but simply flip them end for end – and see what – if any difference this has on the end results!

Cheers

Average, Mean/Median and Compound Annual Growth Rate – what is the difference?

Greetings once again and welcome to the next discussion on these topics. I have created a small table (shown below) to illustrate the differences using a simple representative 20-year period that overlaps the market events of mid-2000 years. Charts and tables that project growth rates over long periods of time are always suspect, but we need to start somewhere. I have chosen 20 years as a period to which most people can relate. Most industry charts cover periods of 60 years and longer and show calculated results going back to day one – while interesting, I feel they are of very little value and clients find them confusing and relating to that duration is hard.

Average versus Median versus Compound Annual Growth Rate – initial investment of $1,000.00 January 1st, 1992.

1992 . . . . . . . 7.8 % $1,078.00
1993 . . . . . . .-4.6 % $1,028.41
1994 . . . . . . .29.0 % $1,326.65
1995 . . . . . . .-2.5 % $1,293.49
1996 . . . . . . .11.9 % $1,447.41
1997 . . . . . . .25.7 % $1,819.39
1998 . . . . . . .13.0 % $2,055.92
1999 . . . . . . .-3.2 % $1,990.13
2000 . . . . . . .19.7 % $2,382.18
2001 . . . . . . . .6.2 % $2,529.88
2002 . . . . . . -13.9 % $2,178.22
2003 . . . . . . -14.0 % $1,873.27
2004 . . . . . . .24.3 % $2,328.48
2005 . . . . . . .12.5 % $2,619.54
2006 . . . . . . .21.9 % $3,193.22
2007 . . . . . . .14.5 % $3,656.23
2008 . . . . . . . .7.2 % $3,919.48
2009 . . . . . . -35.0 % $2,547.66
2010 . . . . . . .30.7 % $3,329.79
2011 . . . . . . -14.4 % $2,850.30

Average . . . . .6.84 % $3,755.58

Median . . . . .9.85 % $6,546.38

CAGR . . . . . . 5.38 % $2,850.30

Total Growth Rate includes Interest, Dividend, Capital Gains and Capital Losses for a nominal portfolio based on 100% of the S&P/TSX. Rates are for illustration purposes only.

A simple average of the Annual Growth rates, results in a number of 6.84%, the median/mean is 9.85% while the actual Compound Annual Growth Rate equates to 5.38%. Please note the comments/disclaimer at the bottom of the table.

So now the question becomes, which rate do we use for financial, insurance and estate planning – assuming that the portfolio described matches the risk and KYC profile of the client.

The mean or median rate is obviously not valid as this simply means that half the returns were higher than 9.85% and half were lower – and the answer is really – so what! That leaves the average or the CAGR.

The table shows that if we use the average rate of 6.84% and compound that for the 20 years, you or your client will only have $3,755.58 – significantly MORE than the actual result of $2,850.30 using the CAGR of 5.38%. An argument can be made for using either one, but speaking personally, my comfort with higher rates has reduced over my career and I would always use the LOWER of the two numbers and would recommend this approach to both consumers and advisors. If you use the lower rate, you are unlikely to be disappointed while using the higher figure introduces a higher level of uncertainty into all calculations. I will point out – that I am not satisfied with using the 5.38% rate either as you will see in the next couple of blogs – too many uncertainties still arise – but 5.38% is at least something closer to reality that what I see being used in most financial planning scenarios, software and insurance illustrations.

This discussion is far from over – there are four other issues to discuss in future blogs: first – what about the effects of inflation on the results; second – what about the impact of income taxes; third – so far I have only looked at a single lump sum deposit – what happens with periodic deposits or withdrawals; fourth – what are the effects of reversing this illustrated sequence of results?

BTW, here is a link to a website that can do all of these financial calculations without requiring a financial calculator – I use it regularly! The S&P/TSX Total Returns I pulled from Jim Otar’s Retirement Calculator – I provide a link to his excellent website in an earlier blog. http://bing.search.sympatico.ca/?q=calculating%20rate%20of%20return&mkt=en-ca&setLang=en-CA

S (and) P/TSX INDEX VERSUS DOWJONES INDUSTRIAL AVERAGE AND LET’S ADD INFLATION!

It has been said that there are Liars, Damn Liars and Statisticians – and you can throw in Economists for good measure! Another approach is to ask a mathematician, an accountant and an actuary the result of the formula 2 plus 2 equals what? The mathematician will say 4, the accountant will say that depends (explains a lot about some financial reporting!) and the actuary will ask, what do you want it to equal? Through creative choices, numbers can be made to say just about anything a person desires, if you apply enough “logic” – no matter how flimsy!

Apples to bananas! As we explore the effects of growth rate assumptions on financial, estate and insurance planning, I am going to take a slight detour to briefly discuss two benchmarks commonly in use – the most popular being the S&P/TSX – which is an INDEX, and the DJIA which is an AVERAGE – they are NOT interchangeable nor do they measure the same things!

The DJIA measures the 30 largest (by market cap) US Corporations – subject to annual reviews and adjustments. The S&P/TSX measures (allegedly) the 300 largest (by market cap and not necessarily purely Canadian) companies trading on the TSX. At last count, there are apparently about 290 companies included in the S&P/TSX Index. Finally, one is expressed in CDN currency and the other in US currency so variations in the DJIA, as usually seen in Canada, also reflect exchange rate movements.

As you can see, the DJIA is only a very narrow “measurement” of market value and movement while the S&P/TSX is, at least in theory, a reflection of a much broader market. Very different measurements yet for some reason they are entwined as being very similar, if not identical – and not just by the media, many in the financial services industry are also guilty of this “grouping” for comparison purposes.

The closest US market measurement to the S&P/TSX Index is the S&P 500 Index – as the name implies, measuring the movement of the largest 500 US Companies – also in US Currency and then converted to CDN $ for use here – again adding exchange rate movements to the changing index values.

Many people are unaware that we (Canadians) do have a “large cap” index that is SIMILAR, but not identical to the DJIA – it is the TSX60 – which measures the 60 largest companies trading in Toronto. So, if comparisons about movements, trends, etc. are to be made, it is certainly far more appropriate to compare movements (net of currency exchange effects), between the DJIA and the TSX60. Other major exchanges around the world also have narrower, large cap sub-indices similar to the TSX 60.

For more specific information about the compositions of the various indices and market averages, please refer to their specific websites – or have fun with Wikipedia.

Inflation has been around since someone started to track changes in prices of various goods and services. In Canada, we use the Consumer Price Index as measured by Statistics Canada. All details can be found on their website plus additional information on Wikipedia. Obviously, the basket of “goods and services” in use today is very different than 50 years ago – even 20 years ago – consumer choices and options change – therefore so does the “basket”. In Canada, inflation is separated into a “full measure” of everything and then a variety of sub-indices such as “core” inflation along with others such Health Care, Education, Recreation, etc.

Comparisons between inflation rates amongst various countries is close to impossible – each country is measuring different items, then of course, we may have currency issues that could also affect published rates – check the websites for each country to determine how currency may impact published results.

All too often, people in our industry and in some cases the media, tend to use a single inflation assumption in our planning – which is patently incorrect. When people retire, the effects of inflation are typically higher due to probable higher costs for Health Care and Recreation, while some aspects of the total inflation rate will drop such as business transportation.

I will discuss inflation in planning in more detail in a future blog – my only purpose here is to caution people to be careful about your chosen basis for assumptions during different phases of the planning process – different rates for education costs, health care, recreation, housing, etc. are all appropriate – a single presumption is not!

BTW, I watch Business News Network each morning to catch Marty, Frances and Michael plus their various guests – plus I regularly use their website – www.bnn.ca – for other updates and information on various indices – including the TSX60.

How to Choose a Financial Advisor

No Hype Book Cover Excerpted from No Hype – The Straight Goods on Investing Your Money By Gail BebeeISBN: 978-0-9784455-0-8
Publisher: The Ganneth CompanyAll the investing basics for Canadians from a savvy financial industry outsider
Gail Bebee photo Gail Bebee is Canada’s Independent Voice on Personal Finance. She is a personal finance writer, teacher and speaker. You can contact her at gbebee@gailbebee.com; her website is www.gailbebee.com.

 

If you are like the average Canadian, you want and need help with your investments. Your challenge is to find the right hired help, a financial advisor who suits your personal circumstances.

In the marketplace, most financial services companies offer individual investors a bundled package of investment advice and investment transaction services. Whether or not you opt for one of these bundles, you need to think of these two services separately in order to make the best investment decisions for your personal situation.

Entire books have been written on how to choose a financial advisor. In my opinion, this is overkill since there are only a few choices for obtaining advice. You can be your own financial advisor, i.e., hire yourself. You can hire a financial advisor who does not sell financial products and is paid by charging the client a fee for service. You can hire a financial advisor who is associated with a stockbroker, bank, deposit broker, insurance company or mutual fund company that sells financial products. Finally, you can use a financial advisor for part of your portfolio and be your own advisor for the remainder.

Choosing a financial advisor is a bit like committing to a marriage. You want to get it right because divorce is painful. To help you avoid the pain, use the following guide to select the financial advisor who is right for you.

1.    Decide how much time and effort you are honestly committed to spending to:
•    become knowledgeable about investing,
•    keep current on financial matters and the stock market, and
•    set up and maintain your investing portfolio.
Be brutally honest with yourself. Will you really dedicate the time to become sufficiently knowledgeable about financial matters to be your own financial advisor? Do you have the time to keep current on investing issues? Do you have the personal discipline to monitor your investments on an ongoing basis, reach decisions to buy or sell investments and then act on these decisions?
If you are a disciplined person who will spend the necessary time, then being your own financial advisor is an option. If you decide that you do need help, then use the following guide to select the financial advisor who is right for you.

2.    Decide how much money you have to invest now and estimate how much additional money you will be investing over the next few years. You’ll need to know these numbers because some financial advisors only accept clients with a certain minimum amount of money to invest.

3.    If you don’t have a complete financial plan that covers all aspects of your personal finances, consider completing one before proceeding with the selection of a financial advisor for your investments. For this task, I recommend using a professional financial planner such as a person who holds the Certified Financial Planner (CFP) designation.

4.    Write down what you expect a financial advisor to do for you. Typical expectations for a financial advisor might include some or all of the items listed here:
•    Provide a written overall investment strategy that includes realistic projected return rates and meets your particular needs and objectives.
•    Provide specific investment recommendations (purchase and sale) consistent with your investment strategy and the reasons for the recommendation, including the risks and benefits.
•    Answer any questions about investing and provide ongoing education about investing.
•    Provide advice on the tax implications of different types of investments available and the investments he/she recommends.
•    Provide referrals to other professionals, such as an insurance agent or tax accountant, where appropriate to meet your investing needs.
•    Be easily accessible by telephone.
•    Call monthly with an update.
•    Meet quarterly to review your investments.
•    Contact you promptly if current events (e.g., stock market crash, a sudden sizeable rise in interest rates) have a major impact on your investments.
•    Conduct the purchase and sale of investments in a timely manner at the best available price.
•    Provide clear, understandable and complete written statements of your investments and return rates.
•    Disclose all costs, commissions and fees.

5.    Make a list of questions for a potential financial advisor. Here are some examples of the questions you should ask.
•    What are your qualifications? Look for:
–       a financial designation or designations that fit your specific needs;
–       several years of experience as a financial advisor;
–       knowledgeable in tax laws, as tax plays a major role in the success of your investments;
–       a license to sell at least mutual funds and fixed income products like GICs, as well as any other types of investments of interest to you;
–       a commitment to ongoing education and upgrading.

•    Who else is on your team? Who is your backup if you’re not in the office?
•    How long has your firm been in business? Is the firm a member of an investor protection insurance fund?
•    Does your firm sell investments as well as provide advice? If so, what products are offered?
•    What is your investment philosophy?
•    Do you personally buy and sell financial products for clients? If so, what products are you qualified to sell and what products do you typically recommend?
•    Do you prepare an investment plan for each of your clients based on each client’s personal situation?
•    How often will we talk and/or meet? Where will our meetings be held?
•    How quickly will you respond if I call or email you?
•    How are you paid? What fees does your firm charge for account administration?
•    What research, newsletters, etc., do you and your firm provide to clients? Do you hold educational seminars for clients?
•    What kind of account statements do you provide, and how frequently?
•    How will I know how well my investments are performing? What performance benchmarks do you use?
•    Do you provide statements with the original cost, current market value and return rate of each investment? Will you provide me with an annual return rate for my overall portfolio?
•    What is your firm’s procedure for handling client complaints?

6.    Develop a list of potential advisors. Here are some ways to identify candidates.
•    Canvass your family, friends and business associates to get the names of advisors they would recommend.
•    Find out what financial advisors are available at the bank where you have your account.
•    Consult the “find an advisor” section of the web site of professional financial advisor organizations.
•    Scan the financial media (business sections of newspapers, financial web sites, magazines, etc.) for articles referencing or written by financial advisors.

7.    Sift through the leads you have amassed and make a short list of two or three advisors. Use the questions you have drafted to assist in selecting the candidates.

8.    Interview all the advisors on your short list. Ask each candidate the same questions and take notes on how each one answers.

9.    Take some time to reflect on the interviews and review your interview notes before selecting the best candidate.

10.    Perform your due diligence. Confirm that the chosen advisor and his/her firm have the qualifications and provide the services they have indicated that they offer.

11.    Contact the chosen advisor, indicate your interest in hiring him/her and arrange a meeting to further discuss and finalize your relationship.
Request that the advisor provide a written agreement, usually called an investment policy statement, detailing the terms you have agreed upon. The agreement should cover such things as:
•    the level of risk you are willing to take,
•    the target asset allocation, allowable range in each asset class and process for maintaining the targeted allocation,
•    the range of the expected return rate of your portfolio,
•    any investment restrictions,
•    all fees and when they are charged,
•    frequency and nature of contact with the advisor, and
•    reporting on the performance of your investments including benchmarks used for comparison.

12.    After six months with the new advisor, review the advisor’s performance and decide if he/she has met your expectations. If you are not satisfied, do not hesitate to change advisors. The new advisor should take care of the paperwork required to transfer your account.