Understanding the Differences Between Financial Advisors and Brokers

Advice Channel
Advisors Channel

As a fee-only financial advisor, I am surely biased to this type of advisor. I do think everyday investors are much better off if they have someone in their corner who is recommending a particular investment product because it actually is the best product for them, given their circumstances and life stage. Not because there’s a commission on the sale at the end of the day.

That doesn’t mean, though, that you shouldn’t be mindful of possible issues – and that’s for any financial advisor, whether fee-based or full-service brokers. For that matter, you also should be mindful of potential drawbacks to other options that may seem (superficially, at least) appealing.

Let’s look at the options.

Fee-only financial advisors are considered advantageous because there’s no inherent conflict of interest as there can be with full-service or commission-based brokers. Brokers often recommend investments owned by their company, which is an inherent conflict.  You simply have to consider whether the products recommended are going to be best for your personal financial goals.

What you pay for is financial guidance, planning and assistance. This may be a flat fee. Some advisors charge a percentage of your account’s assets. You may be able to negotiate the amount. But, the fees you pay do not fluctuate according to the type of investments that are being recommended. What you get with this approach is objectivity and investment advice that’s unbiased. Your interests and your advisor’s are aligned.

The commission-based approach to financial advisory services is less the norm today than in the past. You open an account or buy a stock or bond and your advisor gets a percentage. Recurrent trading may also be encouraged – which may not be good for investors with a longer-term perspective. This all can pose a conflict with your best interests and goals.

And on the do-it-yourself front? Well, as attractive as this might sound on the surface, consider the relevance of the saying about the attorney who represents himself. For investment purposes, you might find good information online, but it’s just as likely you’ll find speculative information, if not real fake news. Investing is a risky business; if you don’t have the time or the expertise to do an adequate job of qualifying research, get a professional to help. Your future – financial and otherwise – depends on it.

Speaking of your financial future, it’s never too early to start planning for it. That means Millennials – and even the oldest Generation Zs who are just entering the workforce – should be putting money aside as they think about their long-term financial goals. It’s a challenge, of course, especially for those who are still trying to pay off college. Retirement is maybe too much to think about, right?

With that said, I’ve developed a service package to make it less painless. My new Robo-Advisor Professional service package is specifically targeted to the needs of Millennials and utilizes an in-depth financial data collection sheet, as well as a plan discussion with myself, to collect essential information about your financial background and goals.  This provides a strong base of understanding for clients to invest in ETFs through WealthSimple with a superior portfolio manager with a track record of beating the index.

ETFs are ideal for those with more limited resources, as a “wrapper” around a group of securities. They have a cost advantage over individual stocks and can be traded commission free. They’re similar to mutual funds, but with more flexibility as they can be traded throughout the day, not just once.

Lower gas prices can mean really big TFSA savings!

Many Canadians have grown accustomed to low mortgage rates and strong residential pricing, and now the price of gasoline is leaving a few more bucks in our pockets.  Don’t get too comfortable, because history teaches us that none of this is sustainable.  It is circumstances like the present that make seasoned money managers anxious.  While neophytes are happy to carelessly bathe in the sunshine, experts are usually getting ready for the next storm.  What can you do?  With lower gasoline prices providing some extra cash flow why not use the cash to bolster your savings?

One cloud on the horizon has been getting some attention of late.  The massive global financial stimulus that has caused interest rates to remain low for so long has had a predictable impact on our collective behaviour.  Canadians have borrowed money like there’s no tomorrow.

Household Debt vs Disponable IncomeAccording to data from Statistics Canada, our total borrowing has been on a steady incline since 1990, while servicing the debt has been eating away at our disposable income.  Sure, we tightened our belts some during the financial crisis, but the temptation to borrow at low rates has just been too much to overcome.

It is difficult to save money, when so little of one’s income is disposable.  And most financial advisers would recommend that it doesn’t make a whole bunch of sense to save money at all when you owe money.  It makes far more financial sense to pay down your debt.  Based on numbers alone, this is sound advice.  But our behaviour is seldom governed by numbers alone – we are indeed a complex species.

For example, contributing to your RRSP provides a tax savings in the same year your contribute right?  So where does it go?  A strictly numbers analysis espousing the merits of RRSPs would certainly factor in those savings to illustrate how effective they are at growing your wealth, but I am inclined to agree with the Wealthy Barber (David Chilton) who frequently points out (and I am paraphrasing here) that those dollars you supposedly ‘saved’ were most probably squandered, not saved.  If the tax savings were indeed invested, then it is true that one’s net worth might grow.  However the iPhone, piece of furniture or other consumer good bought with that tax refund hardly qualifies as savings now does it?

Does it make any sense at all to save when wallowing in debt?  I would argue most emphatically YES!  According to an IPSOS Reid poll published in October:  “The average working Canadian believes they would need $45,609 in savings to sustain themselves for a year should they be off work due to illness.”  Where would this money come from?  In real life, a portion of it would be required for food and lodging yet some of it will be needed just to pay the mortgage or rent.  I’d bet that the average Canadian polled would no doubt have seriously underestimated the amount needed to live on while not working (for whatever reason).  In the same poll roughly 68% admitted to having some or lots of debt – suggesting that 1/3rd of Canadians have none?  Pardon me if I suspect that a good percentage of those polled might also have been too embarrassed to answer candidly even if their responses remained anonymous – we are Canadians after all and loathe to taint our conservative image.

Now is an ideal time to bump up your savings!

Where will the extra cash come from to begin a more aggressive savings program?  Let’s start at the gas pump.  We all feel a bit of relief simply watching the price of gasoline come down when fueling, but has anyone really considered how much they might now be pocketing because of lower energy prices?  In April of 2014 Canadians were paying a near-record $1.50 per litre.  Just 6 months ago the price of gasoline in Toronto was 139.9 cents a litre and today (I am writing this on December 10) it is 103.9 cents.  That’s a whopping 25% decrease.  Say a motorist was spending $50 in after-tax dollars a week.  If they price of gas simply stays at 103.9 the cost savings are $12.50 a week which is equivalent to $650 of annual savings requiring about $1000 of your pre-tax income.  If there is more than one vehicle in a family? Let’s keep it simple and assume $1000 in annual family savings simply from the lower gasoline price.  Never mind that other energy costs (heating) and transportation costs (flights) will also create savings.  What if you simply invested that amount every year and earned a rate of return on it?  It will grow to a handsome sum.  Unfortunately, you will have to pay taxes on those returns but more about that later.

Growth in $1000 annually

 

Of course it’s unreasonable to expect gas prices to remain at these levels or fall lower.  It is also not wise to anticipate more generous rates of return.  In point of fact, it is foolhardy to expect or anticipate anything at all.  Returns will be what they will be, and gas prices are determined by market forces that the experts have trouble understanding.

Does the uncertainty we must live with mean that savings might just as well be spent on the fly?  As I tell students studying to be financial planners; one must start somewhere and there are two things worth acknowledging up front:

1)  The power of compounding (letting money earn money by investing it) is very real, as evidenced by the table.

2)  It makes sense to have a cushion in the event of a loss of income, the desire to pay down some debt, make a purchase or just retire.

Yes it makes more financial sense to have no debt at all, but the majority of Canadians will borrow for those things they want now rather than later, like a home or car.  If you must borrow, why not save as well?  Fortunately we have been gifted the perfect savings vehicle.  The Tax Free Savings Account introduced in 2009 has advantages that make it an ideal place to park money you are saving at the gas pump.  The returns you earn in the account are tax-free.  With GIC rates as low as they are, you might be inclined to say ‘so big deal?’ But any financial adviser over 45 years of age (I admit, there aren’t many) can tell you that low interest rates are temporary, and besides you can and will earn better returns over the longer term in equity mutual funds just as an example.

TFSA Contribution LimitsOf course there are limits (see table) to what you are allowed to contribute, but best of all they are cumulative.  In other words, if you haven’t contributed your limit since 2009, you can ‘catch up’ at any time.  Including 2014, you have a right to have put up to $31,000 into the account.   Also the contribution limit rises (is indexed) over time with the rate of inflation.  Perhaps most important, you can withdraw money from the account tax-free.  Your contributions were already taxed (there’s no tax deduction when contributing like when you put funds into an RRSP), and the investment returns are all yours to keep.  Using your TFSA means that won’t have to pay those taxes and the effects of compounding aren’t diminished.  To top it off, you are allowed to replace any money you’ve withdrawn in following years.

The seasoned money manager will want some flexibility in the event that he is blindsided.  With your TFSA savings you too will enjoy more flexibility.  If interest rates are higher when you renegotiate your mortgage, taking money out of your TFSA to reduce the principal amount might help reduce your monthly payments to affordable levels.  Should the economy take a turn for the worse over the next several years and you lose your job, then you’ll have some extra cash available to retire debt and help with living expenses.  For younger Canadians saving money at the gas pump? Investing the extra cash flow in your TFSA account will certainly help towards building a healthy deposit for your first home.

  • Don’t squander the cash you are saving thanks to low energy prices.
  • Your TSFA if you have one, allows you to invest those savings and the returns you earn are tax free.
  • If you don’t have a TFSA, then get one.
  • Be sure to use only qualified investments and do not over-contribute. The penalties are severe.
  • Money earned on your investments is tax-free.
  • Take out cash when you need it, and put it back when you can.
  • When you retire, money withdrawn from your TFSA does not count as taxable income.

 

Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.
Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.

 

 

 

 

 

 

 

 

 

 

 

 

 

How to Tell the Difference Between Investing and Gambling!

gamblingI saw a question posted on a popular social network. The question was: ‘What is the difference between gambling and investing?” I’m inspired to reproduce (edited with permission) the following excerpt from A Maverick Investor’s Guidebook (Insomniac Press, 2011) which I believe provides as good an answer as one might find.

How to Tell the Difference Between Investing and Gambling!

“How do you develop ‘smart thinking’ and when do you know you’ve got ‘avarice’?”

My instinctive response would be: “You always know when you’re being greedy. You just want someone else to say that your greed is okay.” Well, I’ll say it then: greed is okay. The proviso is that you fully understand when greed is motivating your decision and live with the consequences. Avarice is driven by desire, which is not a trait of an investor.

Remember, it’s best if investment decisions are rational and stripped of emotion. Greed is associated with elation on the one hand, and anger (usually directed at oneself) on the other hand.

When decisions are motivated by greed, I call it gambling. In my mind, there are different sorts of gamblers. Some gamblers place modest bets, and if they win, they move along to another game. For me this might be roulette. There are those who enjoy playing one game they’re good at, such as blackjack or craps, hoping for a big score. Finally, there are those who are addicts. I can’t help those folks, so let’s assume we’re just discussing the first two types.

It’s okay to do a bit of gambling with a modest part of your disposable income. In fact, investors can apply some of what they know and have fun too. Unlike the casinos, financial markets have no limits or games stacked in favour of the house. It’s the Wild West, and if an investor understands herd behaviour and the merits of contrarian thinking, and does some research, the results can be quite lucrative. Whether using stocks, bonds, options, hedge funds, domestic mutual funds, foreign equity or debt funds, or commodity exchange-traded funds (if you don’t know what these things are and want to know, buy a book that introduces investment theory and the various types of securities), applying investment principles will help you be more successful.

gamblerTo put it plainly: counting cards may not be allowed in a casino, but anything goes when it comes to markets. Just don’t forget that most of the financial industry is trying to make your money their money. There’s a reason why a cowboy sleeps with his boots on and his gun within reach.

The fine line between gambling and investing is hard even for old cowhands to pinpoint. Investing also involves bets, but the bets are calculated. Every decision an investor makes involves a calculated bet—whether it’s to be in the market or not at all, biasing a portfolio in favour of stocks versus bonds, skewing stock selection in favour of one or several industry groups, or picking individual stocks or other types of securities.

I met a lady once in line at a convenience store. She bought a handful of lottery tickets, and I asked her, “Aren’t the odds of winning pretty remote for those lotteries?” Her reply was, “The odds are good. There’s a fifty/fifty chance of me winning.” Confused, I asked, “How do you figure?” I laughed aloud when she said, “Either I win or I lose; that’s fifty/fifty, isn’t it?”

A maverick investor knows there’s always a probability that any decision to buy or sell or hold can prove to be incorrect. The objective is to minimize that probability as much as is feasible. It’s impossible to make it zero. This is why financial firms have sold so many “guaranteed” funds lately. People love the idea, however impossible, of being allowed to gamble with no chance of losing. Whenever there’s a promise that you won’t lose or some other similar guarantee, my senses fire up a warning flare.

There’s usually a promise of significant upside potential and a guarantee that at worst you’ll get all (or a portion) of your original investment back. Many investors a few years ago bought so-called guaranteed funds only to find that the best they ever did receive was the guaranteed amount (extremely disappointing) or much less after the fees were paid to the company offering the product. If you think this stuff is new, trust me, it’s not.

guaranteedA fancy formula-based strategy back in the ‘80s called “portfolio insurance” was popular for a brief period. An estimated $60 billion of institutional money was invested in this form of “dynamic hedging.” It isn’t important to know in detail how the math works. Basically, if a particular asset class (stocks, bonds, or short-term securities) goes up, then you could “afford” to take more risk because you are richer on paper anyway, so the program would then buy more of a good thing. If this better-performing asset class suddenly stopped performing, you simply sold it quickly to lock in your profits. The problem was that all these programs wanted to sell stocks on the same day, and when everyone decides they want to sell and there are no buyers, you get a stalemate.

The “insurance” might have worked if you actually could sell the securities just because you wanted to, but if you can’t sell, you suffer along with everyone else—the notional guarantee isn’t worth the paper it’s printed on. Remember these are markets, and even though you see a price in the newspaper or your computer screen for a stock, there’s no trade unless someone will step up to buy stock from you. The market crash that began on Black Monday— October 19, 1987—was, in my opinion, fuelled by portfolio insurance programs. The market was going down, so the programs began selling stocks all at once. There weren’t nearly enough buyers to trade with. By the end of October ’87, stock markets in Hong Kong had fallen 45.5%, and others had fallen as follows: Australia 41.8%, Spain 31%, the U.K. 26.4%, the U.S. 22.7%, and Canada 22.5%.

Minimizing the Probability of Stupidity

If you’re gambling, follow the same steps you would as if you were investing. If it’s a particular stock you are anxious to own, do some homework, or at least look at someone else’s research available through your broker or on the Internet. When I was a younger portfolio manager, there were limited means to learn about a company. I would have to call the company and ask for a hardcopy annual report to be sent to me. When it arrived after several days, I’d study it a bit so I didn’t sound too ignorant, then I’d call and try to get an executive (controller, VP finance, or investor relations manager) to talk to me. If asking questions didn’t satisfy my need to know, then I’d ask to come and meet with them in the flesh. Nowadays, you have all the information you need at your fingertips.

Money.ca is a PRIME example of just one such source of valuable information available to investors today!

Mal Spooner
Mal Spooner

Banks own the investment industry! A good thing?

Let’s face it!  In the battle for investment dollars the Canadian banks are clearly the winners!  Is this a good thing?

Once upon a time, the investment business was more of a cottage industry.  Portfolio manager and investment broker were ‘professions’ rather than jobs.  Smaller independent firms specialized in looking after their clients’ savings.  There were no investment ‘products.’  The landscape began to change dramatically – in 1988 RBC bought Dominion Securities, CIBC bought Wood Gundy and so on – when the banks decided to diversify away from lending and began their move into investment banking, wealth management and mutual funds.

Take mutual funds for example.  Over the past few decades Canadian banks have continued to grow their share of total mutual fund sales* – this should not surprising since by acquisition and organic growth in their wealth management divisions they now own the lion’s share of the distribution networks (bank branches, brokerage firms, online trading).

An added strategic advantage most recently has been the capability of the banks to successfully market fixed income funds since the financial crisis. Risk averse investors want to preserve their capital and have embraced bond and money market funds as well as balanced funds while eschewing equity funds altogether. With waning fund flows into stock markets, how can equity valuations rise?  It’s a self-fulfilling prophecy.

Many of the independent fund companies, born decades ago during times when bonds performed badly (inflation, rising interest rates) and stocks were the flavor of the day, continue to focus on their superior equity management expertise.  Unfortunately for the past few years they are marketing that capability to a disinterested investing public.

The loss in market share* of the independent fund companies to the banks continues unabated. Regulatory trends also make it increasingly difficult for the independent fund companies to compete.  Distribution networks nowadays (brokers, financial planners) require a huge and costly infrastructure to meet compliance rules.  Perhaps I’m oversimplifying, but once a financial institution has invested huge money in such a platform does it make sense to then encourage its investment advisers and planners to use third party funds?  Not really! Why not insist either explicitly (approved lists) or implicitly (higher commissions or other incentives) that the bank’s own funds be used?

Stricter compliance has made it extremely difficult for investment advisers to do what they used to do, i.e. pick individual stocks and bonds.  In Canada, regulators have made putting clients into mutual funds more of a burden in recent years.

To a significant degree, mutual fund regulations have contributed to the rapid growth of ETF’s (Exchange-Traded Funds).    An adviser will be confronted by a mountain of paperwork if he recommends a stock – suitability, risk, know-your-client rules) or even a mutual fund.  An ETF is less risky than a stock, and can be purchased and sold more readily in client accounts by trading them in the stock markets.  Independent fund companies that introduced the first ETF’s did well enough for a time but not surprisingly the banks are quickly responding by introducing their own exchange-traded funds.  For example:

TORONTO, ONTARIO–(Marketwire – Nov. 20, 2012) – BMO Asset Management Inc. (BMO AM) today introduced four new funds to its Exchange Traded Fund (ETF)* product suite.

In fact, the new ETF’s launched by Bank of Montreal grew 48.3% in 2011.  When it comes to the investment fund industry, go big or go home!  You’d think that Claymore Investment’s ETF’s would have it made with over $6 Billion in assets under management (AUM) but alas the company was recently bought by Blackrock, the largest money manager in the world with $29 Billion under management.  It will be interesting to see if the likes of Blackrock will have staying power in Canada against the banks.  After all RBC has total bank assets twenty-five times that figure.  Survival in the business of investment funds, and perhaps wealth management in general depends on the beneficence of the Big Five.

Admittedly, the foray of insurance companies  into the investment industry has been aggressive and successful for the most part.  With distribution capability and scale they certainly can compete, but the banks have a huge head start.  Most insurance companies are only beginning to build out their wealth management divisions.  I can see a logical fit between insurance and investments from a financial planning perspective, but then the banks know this and have already begun to encroach on the insurance side of the equation.  Nevertheless I would not discount the ability of the insurance companies to capture signficant market share.

So, is it a good thing that larger financial institutions own the investment industry?  Consider the world of medicine.  No doubt a seasoned general practitioner will feel nostalgic for days gone by when patients viewed them as experts and trusted their every judgement.  The owner of the corner hardware store no doubt holds fond memories of those days before the coming of Home Depot.  Part of me wants to believe that investors were better served before the banks stampeded into the industry but I’d just be fooling myself.  Although consolidation has resulted in fewer but more powerful industry leaders, the truth is that never before have investors had so wide an array of choices.  Hospitals today are filled with medical specialists, while banks and insurance companies too are bursting at the seams with financial specialists.

It is not fun becoming a dinosaur, but this general practitioner has to admit progress is unstoppable.

Malvin Spooner

 

 

 

 

 

 

 

 

*The industry charts are courtesy of the third quarter Scotiabank research report Mutual Fund Review.  The annotations are my own.