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moneysense.ca, 17/08/10
The Paradox of Financial Advice
In a recent blog post, Jon Chevreau argued that even smart do-it-yourself investors can benefit from good financial advice. While I agree that good financial advice may well be worth paying for, those who might benefit the most from even basic financial advice are faced with a problem. The average financial advisor is nothing more than a glorified mutual fund salesperson who rarely provides the following services that The Investment Funds Institute of Canada trumpets in its report titled The Value of Advice:
- Setting and achieving planning targets
- Choosing the right vehicles and plans
- Setting the right investment mix
Clients who own a potpourri of mutual funds in their investment accounts are ideal candidates for getting some quality advice. But these clients have to be reasonably knowledgeable about financial matters to (a) hire a competent professional and (b) be assured that the advisor is doing the job. But if they have the knowledge in the first place, they might as well go the extra distance and become do-it-yourselfers.
moneysense.ca, 17/08/10
I completely agree. Individuals using a financial advisor still need to become very knowledgeable in investing. That’s the only way they can effectively evaluate the recommendations provided.
I think that the good financial advice that smart DIYers can use would come in the form of tax planning, not from a financial advisor selling the latest mutual fund of the day.
Even though I tend to manage my own finances, I do think there is some value in getting outside perspectives and advice. However, the forms that advice takes is revolutionary today. The traditional, “sit-down” advisor, isn’t necessarily the only way to get great advice. But the principle remains true… it’s beneficial to get great advice and outside perspective!
I’m only just beginning to invest, but I’ve been reading financial blogs long enough now that I know I need more than mutual funds. Unfortunately, it seems to be all I have access to at the moment. I’m very interested in index funds, but I don’t even know where to buy them. The other side of that is besides the small amounts I’m putting into RRSPs regularly, I don’t have any significant sum to invest. I guess I’ll just keep reading until I’ve ammassed enough cash and then try to figure it out.
How do we expect individuals to become knowledgeable in investing? It requires time and interest! Time might be more lacking than interest. Using the school program curriculum might help these young adults later on…
@Melanie Samson. I’m not a financial advisor – I’m just a DIY investor myself so take my advice with a grain of salt. But here is my answer to your question and my advice…
Index funds come in two forms, one which is called an “exchange traded fund” which is bought and sold like a stock on the stock exhange. Like a stock, there is a transaction fee each time you buy or sell the fund – so in short, if you’re looking to invest in small amounts, then exchange traded funds probably aren’t right for you.
Most discount brokerages (say, for example, through our Big 5 banks) offer index funds through the traditional mutual fund sales channels. Each brokerage should be able to provide you with a list of index funds available to you and shop around to find a brokerage that doesn’t charge for the sales transaction.
Pay close attention to what is called the MER (or management expense ratio), expressed as a percentage number – the lower the number the better. For an index fund, you should try to find something below 1% as a minimum. This “management expense” is how much that the company is skimming off the top of your investment holdings to pay for their expenses and salaries and such. The broker usually earns a kickback that is taken out of this “management fee”, so remember that the broker is motivated to put you into funds with higher “management fees” because they make more money in kickbacks.
Just one man’s suggestion – but once your total portfolio exceeds about $100,000 in size, you may want to start to consider moving away from mutual funds and start buying individual stocks. When you hit the $100K mark, a 1% MER means that you’re essentially paying $1000 per year in fees. If you buy the stock on the stock exchange, you pay for the transaction, but you don’t have to pay every year just to hang onto it.
In my experience, interest is lacking just as much as time. Many smart people who could do it themselves simply don’t have the interest. There are so many better ways to use time, for them. Further, it’s not necessary to be financially knowledgable to hire a trustworthy advisor and ensure they’re doing a good job. What people need to do is to meet with a number of different advisors, know what job you are hiring them for, find out what their expertise is, and understand that none of them can control returns. The idea is not to have a predictable journey to wealth, but to be able to sleep well along the way.
I believe Melanie has summed up the problem neatly. Most people simply don’t know where to look. And since money is a conversational taboo, they rarely ask. So many people meet with a single advisor (or salesperson, more likely) and think “good enough,” when they have nothing to compare.
@ CC – nicely said
@ Phil – I like it: once your total portfolio exceeds about $100,000 in size, start buying individual stocks for your equity portion of your portfolio. You can start building a nice lil’ portfolio of dividend-payers that would otherwise own in your index fund or ETF – and not pay a management cent for doing so. Pay for the transcation once, and hold forever.
Anyone else doing this, considering this? Why, why not?
@ Financial Cents – For those folks who want to get into equities a bit sooner, TD Waterhouse waives their annual account fees once your portfolio reaches $25k (saves $100/year). But you still pay $29/trade until the portfolio reaches $100k
@Echo: I agree. I see value in specialized advice such as tax and estate planning but by “advice” here we mean investment advice. Investment advice can be worth the cost IMO, it’s just that most advisors aren’t very good.
@Doctor Stock: Perhaps. Personally, I see no value in investment advice. But I do think that many investors can benefit from another perspective especially when markets are being insane.
@Melanie: I’ve written about investing in index funds many times in the past. Here’s an old post that may be especially relevant:
http://www.canadiancapitalist.com/investing-small-amounts-of-money/
You can find many more posts here:
http://www.canadiancapitalist.com/category/investing/sleepy-portfolio/
and here:
http://www.canadiancapitalist.com/category/investing/
You may be interested in the archives here:
http://www.canadiancapitalist.com/sitemap.xml
@BTI, @Robert: Fair enough. It would be nice if you can walk into any advisor’s office and be reasonably sure that they will be competent. Unfortunately, that’s not the case today.
@Financial Cents: I don’t do stocks, simply because low-cost ETFs can do the job for you. If all you are looking for is market type returns, why even bother with stocks?
@Phil S: You’re right that if you’re paying 1% MERs then indexing becomes expensive for large portfolios. But no one needs yo pay anything close to 1% for an index portfolio. A well designed ETF portfolio should cost no more than 35 or 40 basis points. Meanwhile, to build a diversified stock portfolio you would need at least 25 to 30 stocks (some would argue much more), which would carry a lot of commissions. It would be hard to argue that purchasing individual securities is more cost-effective than indexing. That’s why even institutional investors often use ETFs.
@ Financial Cents: Personally, I have my regular investment contributions to my index funds, and any money left in my ‘entertainment’ portion of my monthly budget can be used for individual stocks. If their dividends and growth beat the index, great. If not, that’s okay too, as the amount is small and not factored into my long-term plan. I do hold those equities in a TFSA though.
@CC: As I am always a skeptic when it comes to unreferenced claims, can you give a specific example or a source to support your claim of an institutional investor using ETFs?
My thinking (without thinking too much about it) would be that an institutional investor would still shy away from the low MER ETFs and just structure a portfolio similar to the ETF with individual securities. Just as was mentioned above, it makes sense to switch from funds to ETFs at a certain portfolio size, so wouldn’t there also be a portfolio size where it becomes cost effective to switch to individual securities?
@AKA: Just to clarify, the comment that institutional investors use ETFs isn’t mine. I agree with you that large institutional investors might choose to simply invest in individual securities to mirror the index. It’s not just the MER savings. The institution could generate extra income from securities lending.
Still, it does appear that institutional investors like ETFs for tactical asset allocation:
http://etfdb.com/2010/study-institutional-investors-piling-into-etfs/
@ AKA: Sounds like you’re similar to me, I have regular, monthly investment contributions to RRSP to buy/rebalance ETFs, other money filtered to dividend-paying stocks that are unregistered.
@ CC: I guess I do both a) low-cost index investing and b) dividend-investing because I want the best of both worlds. I recall you only index invest, now, and used to be into dividend-investing?
The latter is great for me because of the passive income I get, and can reinvest as I choose, and I get the Canadian dividend-tax credit.
@ Echo – yes, you’re right, TD Waterhouse waives their annual account fees once your portfolio reaches $25 K (I like that
and actually, you can start taking advantage of cheaper trades/lower commissions with TD Waterhouse once your household accounts (not just personal accounts) are > $100 K. That’s how my wife and I reduced our fees!
@Couch Potato. Melanie expressed that she is just beginning to invest. I didn’t want to get into the ins & outs of all the different options because I figured hitting the $100K mark may be a few years down the road. All I’m really saying is that for her, she may want to re-evaluate the simple indexing strategy with mutual funds when she gets over the $100K mark.
I usually use $100K as a watermark when giving investing advice – that’s also usually the cutoff where so-called “financial advisers” become “interested” in taking on a “client”.
But since you opened that can of worms, I still think she should buy individual investments at that point. Diversify by buying some GICs, for example. For GICs, I usually recommend a GIC ladder, so you always have one maturing and then buying a new one each and every year over the 5 yr term. It just takes 5 yrs to build the ladder.
I also disagree with your premise that you need 25 to 30 stocks to follow an index. For example, I’ve found that the Big 5 banks generally move in tandem. I’d venture to say that you can pick the highest quality one among them, let’s say RBC for argument’s sake shakes out as your favourite – that one stock would follow the trend. Canada’s largest insurance companies are in the doghouse right now, but I think if you decided you like Great-West the best, it will represent the general direction of the insurers. RioCan is the largest of the Canadian REITs, so any index fund of REITs would be most heavily influenced by that one stock anyways. Yada yada. You don’t need to own EVERY stock to move in the same direction as the TSX… In my humble opinion.
@Financial Cents – For those looking for cheaper trades, I believe Scotia iTrade offers lower commissions starting at $50k of assets.
@Phil S – While I agree that you don’t need to own EVERY stock, owning just the “best” ONE in each sector would be trading off fewer commissions for increased risk. There’s always the chance that a single event could impact one company (e.g. one bad trader, some bad decisions at one bank vs. another) and ruin the person’s entire indexing approach. That being said, re-evaluating the funds once over $100k is a good approach and can’t hurt
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