Ask hard questions of your advisor

When you visit your family doctor, does she always immediately remember all the facts about your medical history? Probably not. More likely, she has a file folder of information on the desk in from of her which she hasn’t had time to even glance at because she’s so busy. After all, she sees scores of patients every week. You can’t expect her to keep them all straight in her mind, competent though she may be.

So you will probably find yourself reminding her of some things during the consultation. She’ll then check back in the files, find the relevant note or prescription, and move forward from there.

Financial advisors are no different. They too have scores of clients, perhaps hundreds. In some cases, they may review the file thoroughly before a meeting. But you shouldn’t take that for granted.

Every advisor is required to have you fill out a “know your client” form when you open an account. But that’s no guarantee that the form will be frequently reviewed or updated. Financial advisors, like other professionals, have heavy workloads and can’t stay on top of every detail. So, as with your doctor, it’s up to you to show some initiative and make sure the advice yoare receiving is actually appropriate for your needs and priorities. That means asking probing questions before finalizing any investment decision. Always remember: it’s your money.

This may seem like very basic advice. But we continue to receive e-mails from readers who feel their advisors led them in the wrong direction and are now seeking other solutions.

Like other professionals, financial advisors are not perfect. They can make errors in judgment too. But you can minimize the chances of that happening by playing an active role in the investment process. Don’t assume that because your advisor recommends a particular mutual fund that it is the perfect choice for your portfolio. Here are some of the questions to ask before giving your approval.

Tell me how this particular fund meets my investment criteria. The answer to this question will be an immediate tip-off as to how much homework the advisor has done before the meeting. If he fumbles around or gives some vague, general response, you should immediately be on your guard. What should happen is that the advisor will explain exactly where the recommended fund fits into the portfolio, how it will enhance performance in relation to your overall goals, and what, if anything, it will replace and why.

How does this fund differ from the others I now own? You’d be surprised at how many investors end up with three or four funds that are managed in basically the same way. For example, there is no reason why your portfolio should contain more than one of CI Canadian Investment Fund, Harbour Fund, or Mackenzie Ivy Canadian Fund. The managers are different but the style is much the same in each case. So have your advisor explain how the fund now being recommended differs from everything else you own. Or, if he is suggesting a replacement for a similar type of fund, ask why this one is better.

How has it performed relative to its peer group and its benchmark index? Sometimes a fund can have what appear to be terrific numbers and still be an underperformer. For example, look at the AGF Canadian Small Cap Fund. It gained almost 42 per cent in the year to March 31. Impressive, right? No! The average fund of its type advanced 51 per cent in the same period. The benchmark BMO Nesbitt Burns Canadian Small Cap Index gained 65 per cent. In fact, this fund has underperformed over all time periods and has a poor risk rating. Yet people have invested $345 million in it. Somebody has been giving some bad advice!

What is the risk rating of this fund compared to others in the same category? Ever since the bear market of 2000-2002 brutally reminded us that stocks can go down as well as up, people have been more conscious of risk. Remember, every investment decision involves a risk/return trade-off. But you need to know exactly how much risk you are assuming before making a commitment. All the fund rating companies have risk measures that compare funds to others of the same type. Find out where the one that is being recommended stands in the risk pecking order. And don’t just rely on numbers. Ask if the fund has any special risk characteristics that you should be aware of. For example, if it is an income fund find out what percentage of the portfolio is in income trusts (higher risk) and what percentage is in cash and short-term bonds (lower risk).

What are the tax implications of investing in this fund? If you are buying the fund for a non-registered portfolio, ask about its tax history. If it is an equity fund, does it have a record of paying high annual distributions, which will be taxed in the year received? If it is an income fund, what percentage of the distributions is tax-deferred or tax-advantaged?

If I invest in this fund, how will it change the asset mix in my portfolio? Will the revised asset mix be consistent with my overall objectives? You need to know whether the addition of one or more new funds will create a significant change in your portfolio balance. Ask for a break-down of your current asset mix and for a projection of what it will look like if the recommendation is implemented. If there is a change, ask the advisor to explain why he believes this is to your advantage and whether it will add more risk.

What is the fund’s management expense ratio and how does it compare with the average for its category? Canadians should be more concerned that they seem to be about the annual fees they pay fund managers for looking after their money. In some cases, those fees are excessive. Often, a large percentage of the fee goes back to your broker for on-going advice. Make sure you are getting your money’s worth.

What types of units does this fund offer? Fund investors are faced with an ever-expanding array of choices when it comes to which type of units to buy. Unfortunately, there is no consistency in the way these units are labelled and each company offers its own selections. Some types of units are much less expensive than others. For example, if you can acquire “F” units, they are usually the best value. Some funds now also have “D” units which are also worth investigating. Ask for a complete explanation of all the choices available.

What compensation will you receive if I invest in this fund? You have every right to know this since ultimately it is your money that will be used to pay the advisor. So don’t be shy about it. Also, ask how the compensation will change depending on the type of units you buy.

Of course, it will take some time to go through all these questions with an advisor. But every one of them is important and you have the right to some clear answers. If the advisor seems impatient or fudges, it’s time to look elsewhere for help.

This article originally appeared in Mutual Funds Update