Make sure it’s good advice

When you were earning double-digit returns on your investments, you probably didn’t pay all that much attention to the job of your financial adviser or financial planner – you were making money and that’s what mattered. But with market returns much lower now, it’s become more urgent to monitor your portfolio and understand what your adviser is doing – and could be doing – for you. Problem is, this may not be as easy as it sounds, thanks to the many professional designations and levels of financial advice available.

In Canada, professionals who provide financial advice may hold a number of different titles. Often, those who hold a financial planning designation are called financial planners and those who work for bank-owned securities firms are called investment or financial advisers. However, standardization in the titles used across the country – and even from firm to firm – is still in the works.

Who’s selling what?
Advisers and planners who offer investment products must be licensed accordingly, while certain advisers are licensed to provide investment-counselling services. Among the productyour adviser may be licensed to sell are:

• A full range of mutual funds, from bond funds to international equity mutual funds.
• Various types of securities, including mutual funds, government and corporate bonds, including strip bonds, stocks, index units and income trusts.
• Insurance that covers life, disability, long-term care as well as critical illness.

In terms of service, the latest Financial Advice in Canada survey (conducted by my firm Headspring Consulting Inc. in 2002) surveyed more than 1,400 experienced financial advisers from 20 financial firms across Canada. The three services financial advisers and planners, including brokers, most often provide their clients are: investment selection, pre-retirement planning, and retirement planning for clients who are already retired or close to retirement. Other services offered by some but not all advisers include: tax planning, estate planning, insurance, education planning, cash and debt management, and business owner issues.

Start with a written plan
Eighty per cent of financial advisers and planners who participated in the study reported they had one or more designations related to financial advice and planning. And not long ago, anyone in Canada could hang out a shingle with the title “financial planner.” Now, although pressure from consumers has helped bring about better industry standards, the survey’s findings indicate some qualified financial planners may still be doing an inadequate job: just five per cent of financial advisers and planners report actually preparing a written comprehensive financial plan that encompasses all aspects of the client’s personal financial situation, and just 20 per cent of financial advisers and planners reported preparing a plan for more than half their clients.

Most financial advisers do not charge a separate fee for preparing a financial  plan and, instead, are compensated through the commissions or fees they receive from the investments their clients hold with them. But as a consumer, remember a financial plan must be more than a sales tool linked to the sale of investment products.

A financial plan can help you achieve your financial and lifestyle goals. Especially when markets are volatile, as they have been lately, a financial plan can offer reassurance and help answer the simple question, “Am I going to be okay?” If you don’t have a written plan, request one from your financial adviser or financial planner.

Next page: The cost of advice

The cost of advice
Someone recently told me he didn’t mind paying 2.5 per cent to have his investments managed when he was earning 14 per cent – but in today’s environment, you can be pretty sure he’s paying closer attention to his costs. Certainly, the less you pay for investment management, the greater the assets that stay in your portfolio. But investment returns and advice also matter. You’d make more if your portfolio could earn 10 per cent before an annual fee of 2.5 per cent than if it grew three per cent but only cost one per cent. You also get to keep more when you have a tax-effective plan.

Generally, the more people who handle your money or the more real or perceived services involved in managing your money, the higher the cost. The same principle holds true whether the commodity is coffee – raw beans cost just pennies to grow but costs increase as those beans are roasted and packaged; and if you order them as a cappuccino, it costs even more – or financial advice.

Such costs add up over time. Suppose you start with $100,000 and pay an all-inclusive fee of two per cent annually for advice and to have your money managed. If you earned seven per cent before fees for 20 years, the value of your account could grow to $258,723 – and you’d paid about $69,723 in fees.

With anything you pay for, it’s important to ask yourself whether you’re getting good value for the price you pay. This is harder for buyers of financial advice than for other types of consumers because most Canadians don’t actually receive a bill from their financial institutions; instead, the costs are buried in the cost of the investments.

Still, you can estimate how much you are paying each year. Here’s an example. If you have $100,000 in mutual funds that charge an average management expense ratio of two per cent a year, you’re paying approximately $2,000 in fees annually. As your portfolio grows, the amount in fees also increases.

As well as the value of the services and advice they receive, investors need to consider:

• How much it will cost to become an investor (i.e., what are the initial fees or commissions, if any)?
• What are the on-going costs of being an investor (i.e., on-going management or transaction fees, RRSP fees, other fees)? Over time, these types of fees generally cost more than what it cost to become an investor in the first place.

Commission or fee-based?
Some advisers receive most of their compensation from the companies whose products they sell through commissions and fees based on the size of the client’s portfolio. Others charge their clients directly based on the size of their portfolio or on a fee-for-service basis for the time involved.

You could talk to three financial advisers (who might even work for the same firm), all paid on commission, and find that each provides a very different level of service and advice. Regardless of how they are compensated, financial advisers are not all the same. Some work as professional advisers, others as professional salespeople.

Find the right relationship
Expect to see the financial services industry discussing proposed changes to how those who provide financial advice are regulated. Ontario, for example, has proposed regulation that shifts the focus from transactions and product
to the type of relationship between clients and advisers.

Your adviser should be technically competent so they can build you an investment portfolio based on sound investment principles and your goals and, if they are holding themselves out as a financial planner, to provide you with a plan in writing. What else do you want from your adviser? To help you keep your money? To be trustworthy and to put
your interests above their own? Of course! She or he ultimately works for you.

Seven key questions to ask a potential adviser

1. What investments are you licensed to sell – mutual funds, securities and/or insurance?
2. Do you hold a financial planning designation?
3. Will I receive a written financial plan?
4. Do you work on commissions or fees?
5. What is the annual cost of being a client of your firm?
6. Is your firm a member of the Investment Dealers Association (IDA) or the Mutual Fund Dealers Association (MFDA)?
7. If I hire you, what job description will we be using to evaluate our working relationship?