One of the biggest challenges for individuals in today’s investment industry is obtaining truly independent financial advice. Investors seeking financial advice often encounter two key obstacles. First, they may be forced to select from a set of products that offer very limited choice. Second, they may be forced to deal with an advisor who is heavily motivated by sales incentives to sell a particular product, rather than choose the best product for the client. These points can be illustrated by looking at the financial advice available through bank branches, where typically proprietary products are sold, and independent advisory businesses.
Limited Choice at Bank Branches
The investment products available through your local bank branch are generally funds with the bank’s name on them. Branch employees can direct their clients towards certain packages of funds, but typically, all the funds within the packages are managed by that same bank. This is similar to a restaurant that may have 10 different wines on their list, but they are all from the same winery.
This isn’t necessarily a bad thing – one or two of those funds (or wines) could be the best in class. But often there are better options available and in many cases, at significantly lower costs. While much thought goes into the construction of investment portfolios, if the portfolio managers are only working with one source to create the portfolio they may not be working with the best products for each solution.
Once a customer has made the decision to stick with that bank for their investment needs, the financial advisors are working with a captive audience and do not need to worry about the competition or finding the best value for the client on an ongoing basis.
Let’s take a look at one example of a fund that seeks to match the performance of the TSX. Each bank will offer this type of generic fund and often, the major factor in their success is the fees they charge. The end result is the lower the fee, the closer the return of the fund comes to matching the actual return of the TSX index.
In this example we see four bank owned Canadian Equity Index funds versus the IShares S&P/TSX 60 ETF (Exchange Traded Funds) with an expense of 0.18 per cent. Basically the end result is, the larger the expense, the smaller the return. Remember, the higher expenses compound over time and significantly lower the value of your portfolio.
|Name||10 yr. Ret||TSX 10 yr. Ret||Dif||MER|
|CIBC Canadian Index||6.56||7.75||(1.19)||1.14|
|Scotia Canadian Index||6.69||7.75||(1.06)||0.99|
|National Bank Canadian Index||7.38||7.75||(0.37)||0.66|
|TD Canadian Index – e||7.28||7.75||(0.47)||0.33|
|iShares S&P/TSX 60||7.81||7.75||0.06||0.18|
Advisors and Sales Incentives
Even if a client finds an advisor that has access to the full range of mutual funds, how will they choose? In Canada, there are over 16,000 distinct fund products – far too many for an investor or even a financial advisor to keep track of. In order to drive sales of their own fund products, fund companies will often embed commissions and trailer fees in their funds to incent the financial advisor to sell their product. These fees average around 1 per cent per year and are passed on to the investor. This compensation drives the financial advisor to recommend products that generate higher fees for themselves, despite the impact to the client, and in some cases compromising on the quality of the product. Advisors representing a specific fund manufacturer may also have extra incentives, on top of these high commissions and trailer fees, to push the fund company’s own products ahead of others.
Let’s take a look at a balanced growth portfolio constructed of four funds offered through one of the largest financial advisory firms and fund manufacturers in Canada. Each fund in this example is the firm’s highest selling fund in its respective asset class with at least 10 years of performance. These four funds have an average MER of 2.56 per cent. When we compare the portfolio to a similar portfolio constructed of index ETFs which have an average MER of 0.27 per cent, the advisory firm underperforms and charges significantly more to do so.
On $200,000 invested for 20 years, that’s a performance difference of $140,000 with total fees paid over a 20 year period of $100,000, versus about a tenth of that for the ETF portfolio.
There is a clear story here: the investor’s interests may not be necessarily at the forefront of the advisor’s mind where advisors are compensated by fund companies for selling their funds.
10 Year Return
|Asset Class||Portfolio Weight||Proprietary Mutual Fund Portfolio||ETF Portfolio||Difference|
Key investment lessons
- Seek an advisor who is not limited to one source for the selection of your securities;
- Understand how much you’re paying in fees and where they are going;
- Preferably, work with an advisor who does not earn any sales commissions from the products recommended. This is the only way he/she can truly work in your best interest.
Having access to unbiased, independent financial advice is invaluable. At Invisor, we select our investments based on thoroughly researched risk/return characteristics, security cost, and most importantly, the suitability for our investors’ specific goals and time horizons. We do not receive any commissions from fund companies for including any of the products we’ve selected for our client portfolios.
To learn more about Invisor’s fees and calculate your savings when you invest with us, visit Invisor pricing.
Invisor offers Canadian investors personalized investment management solutions at a fraction of the cost of traditional advisor models, without requiring any minimum investment amounts. Get started now to tell us a little about yourself and your goals, and we’ll find an investment solution just right for you.
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