Wednesday, February 12, 2014

The Gap Between the Financial Advice You Need and What You Get

Most people need financial advice. You don’t need much experience explaining financial matters to people to see that most need help. However, this doesn’t mean we can make the logical leap to saying that people need the services of a typical financial advisor. There is a huge gap between the financial advice people need and what they get from the typical advisor.

The typical financial advisor will choose investments for you (usually high-fee mutual funds) and handle the mechanics of opening accounts and investing your money. While people need some guidance to choose an appropriate asset allocation, the truth is that opening accounts and choosing investments isn’t all that difficult. One option is to take a risk-tolerance quiz and choose one of Canadian Couch Potato’s model portfolios.

Here is a sample of the types of questions that people really need help with:

1. Should I invest in an RRSP, TFSA, RESP, or something else?

2. My advisor wants me to borrow to invest. Should I use leverage?

3. How can I pay my advisor fairly for his or her advice but keep other investment costs to a minimum?

4. The market just dropped 500 points! Should I sell?

5. The market has been climbing crazily lately! Should I buy more stocks?

6. Which accounts should hold my stocks and which should hold bonds?

7. When I retire, how much can I safely spend without running out of money when I’m old?

8. How should I organize my finances to reduce income taxes?

There are great advisors out there who give good advice to their clients on these questions and more, but such advisors are in the minority.

If you think the main job of a financial advisor is to choose investments, then you’ll likely pay a very high price for a fairly simple service. If you think the main job of an advisor is to help you outperform the market, then you’re very likely to be disappointed. Consistently beating the market is exceedingly difficult and an advisor who could really do it likely wouldn’t waste his or her time talking to you.

If you’re going to pay for financial advice, make sure you’re getting the help you need on the difficult questions and not just a person who chooses expensive mutual funds.

10 comments:

  1. Hi Michael,

    I'm not sure if you're looking for topics to blog about but if you are, I'd appreciate your consideration with my question. I want to set aside $100,000 for each of my 2 children today in a total world stock etf on condition that the money cannot be used until the children reach age 50 (currently 12 and 9 years old). Any knowledge on how to do something like this with the least amount of fees?
    Thanks,
    Larry C. from Markham, ON

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    1. @Larry: I'm assuming you don't expect to be around long enough to control the assets until your children are 50. The only solution I'm aware of is a trust, but I'm no expert in these matters. Trusts can be expensive to set up and maintain. Another thing to consider is whether your children will simply borrow against the large sum they will get at age 50. Unless you can set up a structure where lenders are prohibited by law from treating this future money as collateral, I suspect that many lenders would be willing to allow your children to waste the money early. You might consider asking the Blunt Bean Counter for his opinion.

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    2. Thanks for your insight, Michael.
      Larry

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  2. This is a chicken-and-egg problem. One has to be quite knowledgeable to tell if an advisor is any good but with that knowledge one should be fine investing on their own. I personally think most people will be better off just doing the basics right and investing in high interest GICs.

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    1. @CC: You're right about the chicken and egg problem. However, I'm hoping that if people understand at least what are the real things they need help with from an advisor they can avoid the worst advisors.

      One can do worse than just investing in GICs, but I fear that too many will just accept terrible GIC rates from big banks. This brings us back to the chick and egg problem.

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    2. I don't know about that, you pretty much only pace inflation with GICs, so every dollar you want to spend in retirement (above poverty-level entitlements) is a dollar you have to save the hard way in your working years. It requires a lot more budgeting and lowering of expectations than taking on equity risk unless you happen to have a pension.

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    3. @Potato: I think CC was looking at how the typical person invests: balanced fund, MER > 2%, some performance chasing, and the occasional DSC. Compared to this, GICs look less bad.

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    4. I think CC is right. Not that I'm pro-GIC, but at least it's a guaranteed return. Just because "the market" might return 8-10% over the long term does not mean individual investors will achieve those returns. The difference between investment return and investor return is called the behaviour gap - the dumb things we do like buying high and selling low - and it's significant.

      Yes, that does mean you'll have to save a lot more.

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  3. I think many younger investors are anti-GIC because GICs have been ridiculously low for the last 5+ years. But it wasn't always so. As this article in the Globe explains (admittedly while interviewing an author with a very strong pro-GIC bias, over the long term, 30-50 years, GICs averaged about a 7% return.
    http://www.theglobeandmail.com/globe-investor/investment-ideas/buy-gics-only-gics/article4195771/?page=all

    I don't know what the future will hold for GICs. Certainly 30-50 years ago there were no discount online brokerages or "buy the market" very low fee ETFs. Banks gave you a toaster for opening an account and paid you interest on your savings. Now they routinely charge people $1.50 to take out some of their own money and some even charge a fee to know your own bank balance! Different times indeed.

    For sure when I put some money in GICs in my RRSP at 15% I was pleased with my return. Yes, inflation was high then, too, but not as high as the naysayers would have you believe.

    The problem is nothing stays the same, in the markets or in fixed income!

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    1. @Bet Crooks: I have to point out that Trahair routinely omits dividends when comparing GICs to stocks, so you should be cautious about reading what he says.

      It's true that GICs used to give better returns in tax shelters in the past, but you have to focus on real returns. That nominal 7% figure is misleading. For taxable accounts, GICs were actually worse than today in some of the high interest rate years.

      It's true that smart GIC investing in tax-sheltered accounts can work out better than doing a bad job of investing in stocks and bonds. However, a critical part of doing well with GICs is not accepting the poor posted rates from the big banks.

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