Monday, March 31, 2014

What Distinguishes Good Financial Advisors from the Poor Ones?

In a recent post, an anonymous commenter took me to task for my opinion that mutual funds should not be permitted to pay financial advisors. Rather than just rebut the commenter’s argument, I want to use it to illustrate an important difference between good and bad financial advisors.

Here is the criticism edited for length (the original comment is here):
You say “If advisors are performing a valuable service, their clients should be willing to pay them directly.” How do you reconcile this statement with you making money via advertising on your site? If you feel that should be the ONLY model, why not charge people directly for this site? When you go to a store and a salesperson helps you pick out a product, do you pay them separately or assume their compensation is included in the sticker price?
Of course, the reason I don’t try to collect a few pennies each time a reader visits my site is that the overhead would be far too high. It’s obvious which parts of my site are content and which are advertising. Readers can make an informed choice about what they read here.

The analogy between investing and buying a consumer item is far more interesting. It illustrates an important difference between good and bad advisors as I’ll explain.

To put dollar amounts on an equal footing, let’s compare buying a $25,000 car to investing $25,000 in mutual funds.

Consumer View

When I buy a $25,000 car, I think of it as spending $25,000. I know that my money gets split up in some way among the car salesman, the dealership, the manufacturer, and possibly other parties. Knowing the actual split might help me negotiate a lower price, but for the most part I don’t really care how the money gets divided.

When I invest $25,000 with an advisor I don’t think of it as spending at all. I am entrusting my money to an advisor, his firm, and the fund managers. I hope to get back this money and more in the future. I’m entitled to know what fees I pay for the services I get.

When buying a car, I know I’m spending $25,000. But when I invest, most of the money I hand over remains my money. The only amounts that I’m actually spending are the (usually hidden) fees. Over a lifetime these fees can be substantial and investors should be given a reasonable opportunity to understand how much they’re paying.

Advisor View

A good advisor thinks of client money similarly to the way clients think of it; the money is entrusted to the advisor. These advisors see good stewardship of client savings as an obligation.

A car salesperson sees the car purchase process as one of convincing a consumer to buy a car and collecting a cut of the price. The salesperson uses various techniques to close the sale and then moves on to the next potential purchaser. The salesperson has little reason to feel any further obligation to the purchaser, and purchasers generally understand this even if they find the process uncomfortable.

An advisor who sees a parallel between selling consumer items and selling mutual funds is very likely to be a bad advisor not worth a client’s trust. A client expects the advisor to provide ongoing good stewardship of the client’s savings. An advisor who feels no such obligation has deceived the client.


There are important differences between selling consumer items and selling mutual funds that cut to the core of why people go to financial advisors. I don’t believe that government should try to protect people from every possible small harm. However, the treatment people get from a great many financial advisors and the mutual funds they sell is a large harm. Costs over an investing lifetime can easily climb into the 6-figure range and people are generally oblivious to this high cost. I see no effective remedy other than to cut off payments from mutual funds to financial advisors.


  1. Good post as usual, one of my favorite topics.

    Unfortunately the people that get harmed the most aren't signed up to your email subscription as I am for example. The vast majority of people have no idea they are being hosed.

    Secondly "Mr./Ms. Anonymous is also many times simply a bank teller that took an in house "sales course" on how to sell mutual funds and all of a sudden has this fancy sounding title on their business card saying they are an expert "Financial advisor"... It could also be someone recruited by a WFG or Primeamerica type organization, again who the day before was/is still a bartender turned advisor. Just someone looking at making a few dollars on the side of his other career.

    They themselves have no idea what you are trying to say here, just that you are trying to take their commission away unjustly. Thanks to people people like you or Preet, Fair Canada, and a few others trying to get the message out. Not easy but it is appreciated. I try to explain your principle to the accountant and CEO at work about our 2+ % fee pension plan. These are smart people otherwise. You can imagine how frustrating that is for me. But I'm no longer surprised by anything or that response you got.

    1. @Paul: Thanks. I know that my reach is limited, but I'm hopeful that when my readers agree with me they'll take that information to a few others. So, I hope that my reach is a little further than it appears.

      You may be right about the commenter. I get no information about the identity of anonymous commenters. There certainly are many people who call themselves financial advisors who know very little about investing but do know how to calculate their commissions.

      Thanks for putting me in the same company as Preet and Fair Canada. I'm currently trying to explain the problem of high group RRSP fees to my employer as well.

    2. Thanks for your reply.

      Low fee Group Pension plans seem to be hard to find. I got involved in this at my work, called a lot of places, finally got lucky actually through a fan of yours who works for Steadyhand locally. There is at least one decent alternative to traditional GPP's that were willing to offer a group plan, with lower fees, and advise employee's (included) and offer a fiduciary standard.

      Our pension provider brainwashed our accountant with all the usual scare tactics they come up with to not make a switch to the other provider after a year of a small group of us trying. (Belittling their approach and size for the most part). My only consolation is they did several token MER/IMF reductions based on my constant nagging. Still far too high IMO particularly with our AUM with them.

      I received my Fair Canada update mail just today coincidentally. Seems their work has been stalled by the industry as well. Their recommendations of changes to the CSA from 2010 just wind up going nowhere. So I guess I shouldn't feel so bad. These massive companies have a lot of power and this will be a long battle. I'm not sure if it will ever be good news for the individual investor.

    3. @Paul: Our group RRSP provider took an interesting approach. They talked at length about the importance of low fees and showed how their fees were lower than the typical Canadian mutual fund by about 0.5%. They had all kinds of charts showing how big a difference this 0.5% makes. However, my own DIY portfolio is about 1.4% cheaper each year than the cheapest option with my group RRSP.

  2. "I see no effective remedy other than to cut off payments from mutual funds to financial advisors."

    I'd certainly vote for that! :)

    1. @IG: I'm not sure how to make it happen, but a starting place is support.