Use My Questions to Ask Your Financial Advisor
May 2022
I believe your financial advisor should be proactive and answer the following questions without being asked. However, if not, you should ask and then reach your own conclusions as to whether you are receiving the advice you should. In addition to these questions, see the question titled Questions to Ask a Financial Advisor on this site by the Government of Canada, which I also reproduce at the end of this article. Too shy to ask your advisor these questions? You shouldn’t be – it is your money. Just say, “I have a number of questions for you based on advice from a Government of Canada web site [and Blair Corkum’s site]. Bear with me as I work through them.” Or, you can give them a copy of this article, and ask, “Could we work through this list together and you can give me your comments and thoughts?” Sigh, no wonder I have so few friends in the investment business.
Benchmarking – Measuring investment performance
How much did I make on my investments last year? What about an average over 5 years and 10 years (if applicable)? (b)How did my returns compare to the average of all securities for the type of investment I own?
This is called “benchmarking.” Each type of investment you have, or your portfolio as a whole, should be compared to a benchmark to see if your results are average, below average or above average. Knowing this will help you decide if any changes need to be made and if you are receiving good investment advice. Making 10% on your investments may sound good, but if the market average for that type of security was 20%, you did not do so well. On the other hand, if the market average was a negative 10%, and your return was a negative 5%, you did well.
Your portfolio rate of return should be calculated after deducting all fees that are charged to you for investment management. Typical benchmarks that could be used include the following, for either your security portfolio as a whole or for individual mutual funds:
Canadian stocks portfolio – S&P/TSX Composite Index
U.S. stocks portfolio – S&P 500 Index
Canadian bond portfolio – FTSE TMX Canada Universe Bond Index
International equity portfolio – MSCI EAFE Index
However, some brokers will use narrower indices to more closely match your portfolio, or may use an Exchange Traded Fund that tracks an index as an appropriate measure. Where you have a portfolio or mutual fund holding securities of different categories, such as Canadian equities, U.S. equities, Canadian bonds, etc., then your advisor will calculate your personal benchmark by blending appropriate indices in the same proportions. For example a mutual fund with 60% Canadian equities and 40% Canadian bonds would be benchmarked against a measure of 60% S&P/TSX Composite Index and 40% FTSE TMX Canada Universe Bond Index.
Want to know more about calculating your rate of return and benchmarking? MoneySense magazine has some good information on this topic – visit http://www.moneysense.ca/invest/figure-out-your-rate-of-return and http://www.moneysense.ca/invest/how-you-doin. In addition, the Investor Education Fund, an initiative of the Ontario Securities Commission, has information and a benchmark calculator at http://www.getsmarteraboutmoney.ca/tools-and-calculators/portfolio-benchmark-calculator/portfolio-benchmark-calculator.aspx.
Bonds vs. Guaranteed Investment Certificates (GICs) – Which are better?
Should I own bonds or would I be better off buying guaranteed investment certificates (or similar term securities, which may be called term deposits, certificates of deposits, guaranteed income annuities, etc.)? (b) Which way do you think interest rates are going, and how will that impact my bond or GIC portfolio? (c) What other factors affect bond values, and how will they affect risk and return?
The reason for these questions is to ensure you understand the differing risks between fixed income products. One to five-year GICs issued by a chartered bank, for example, are locked in for a specific term, and are guaranteed by the Canada Deposit Insurance Corporation for up to $100,000. (You should investigate further to see the precise rules and limits.) Credit unions and insurance companies also have similar coverage. In contrast, while government and corporate bonds also have fixed terms, they can be bought and sold daily and generally have no insurance protection. While both types of securities have fixed interest rates, a bond can have a capital gain if market interest rates decline. Bonds can have a capital loss if the bond issuer, such as a corporation, defaults or if market interest rates rise. Demand for bonds can change for other reasons, such as the safety of Canadian bonds versus other nation’s bonds, or the risk of default on corporate bonds versus the risk of default by a government. Such factors may increase or decrease bond values. How are bonds doing now and in recent years – see the S&P Dow Jones Indices web site.
The reason for the impact of interest rates may be best explained by an example. Assume I own a bond for $100,000 that pays 2% interest, which is the going market interest rate. If you are looking to buy a bond next year for $100,000, and I am looking to sell mine, we can do a deal, and you would pay me $100,000. However, assume that interest rates declined to 1% over that year. Now, you can only buy new bonds paying 1%, but mine still pays 2%. You would be willing to pay me more than $100,000 so that you can earn more interest; if you pay me $105,000, that will give me a capital gain of $5,000. On the other hand, if interest rates rise to, say 3%, you will not be willing to buy my bond unless I take a discount. Why would you buy my 2% bond if you can buy a new bond paying 3%? If you are willing to buy my bond for $95,000, I now have a capital loss of $5,000.
GICs neither have an opportunity for gains nor the risk of losses if interest rates change. For more information on bond risks, see my article titled Bonds are not Guaranteed – Understand the Difference Between Bonds and GICs.
Ensure you and your advisor understand the risks of bonds versus GICs, and if you do not want to accept the risk, ask if you should switch your bond portfolio to a GIC portfolio. Of course, even with their risk, bonds still add stability and safety to your overall portfolio – they are not as risky as an equity portfolio.
Balanced Funds and Bond Funds – Are fees eroding bond returns?
Given the discussion related to bonds after asking the above question, the next questions only relate to you if you invest in a bond fund or a “balanced fund.” My focus will be on balanced funds, but a bond fund has similar issues. A balanced fund may be a mutual fund or it may be a pool of investments managed by your brokerage firm on which they charge you a management fee. A balanced fund will contain a mix of equities and fixed income (typically bonds). An asset allocation fund, while similar, is not the same. The manager of an asset allocation fund has more leeway to swing from nearly all equities to a high percentage of bonds based on his/her market expectations; a balanced fund manager is required to stay within certain limited allocations based on the terms set out in the mutual fund prospectus.
What can I expect to make as a rate of return on my balanced fund/bond fund over the next five years after deducting the management fees? (b) For my balanced fund, what portion of this return relates to equities and how much relates to bonds?
It is the return on the bond allocation that you should understand for this discussion. Does your advisor expect interest rates to remain the same, with no other impacts that will affect the bond market? If so, your bond rate of return will likely equal the average current yield to maturity of those bonds. If we assume the average yield is 2.0%, and you are paying a 1.75% fee, then your net return is 0.25%. Compare this to a laddered GIC portfolio where you might be able to earn 2% (which should not have fees imposed.) In such a case, you would likely be better off holding your fixed income securities outside of the fund. If your advisor expects interest rates to rise and bonds to decline in value, this would also be a choice to consider. In such a case, with a balanced fund, you would break it in two, moving the equities to an equity fund, and the bonds to GICs, an exchange traded fund, or a low fee bond fund. Keep your balance the same but in separate funds. This is even more important given some studies that show management fees of balanced funds to be just as high as those of equity funds. Of course, in a balanced fund, you are paying someone to change the mix of equities and fixed income as they think is appropriate based on all of their investors as a group. With separate equity and fixed income funds, your advisor needs to work with you and change the mix as appropriate for your specific case.
I am not telling you to do this – I am suggesting to you it is a discussion you need to have with your advisor.
Cost of Investment Advice – What added value is received for the costs?
What did I pay [or will I pay] in advisor fees and commissions last [or next] year? How much is that in dollars and cents? Is this type of fee in my best interest – which is better for me and why? Can I get the same service for a less expensive fee? For example, would it be in my best interests to pay a commission each time I buy or sell, or is it better to pay a percentage fee based on the value of my investments? Why?
If you have a fee that is charged each time you buy or sell, or a fee that is charged monthly or quarterly to your account, you will have your answer already. You just need to take the time to look it up. If you own mutual funds or Exchange Traded Funds, these fees will not be obvious unless you read the related documentation or search for the information on the Internet. Ask your advisor how much you are paying for the MER (Management Expense Ratio) of each fund; he or she will have it readily at hand. Ask for your fees in dollars, not percentages – 1% does not sound like much but if you have $1 million invested, it is $10,000…that sounds like a lot more to me.
Are you getting value for your money? Your advisor, and his/her team, should be adding value to your net worth. To be fair, your individual advisor will likely not be receiving the total fee. Out of an average Canadian equity mutual fund fee of about 2.3%, your adviser will likely be receiving about 1%, with the remaining going to the fund managers who do the buying and selling within the fund. However, it is the total cost that is important to you, although it is your individual broker who is paid to provide you with your answers. If you are paying high fees and receiving low rates of return over a period of several years, you need to do some comparison shopping.
Feel free to ask, “How much of this fee do you receive?” “You do not pay me, my company does that” is not the answer you should expect. While some advisors are paid by salary, most receive commissions, trailer fees and bonuses (even for salaried individuals) based on their sales growth and volume of investment assets under their management. If you own mutual funds and are told that they do not receive any commissions or trailer fees, ask if you have “F Class” funds. F Class funds have lower fees because they do not pay trailer fees to the advisors. If you do not have F Class funds, ask who gets the trailer fee (typically about 1% on an equity fund). I was once told by a bank advisor that they received no commissions or trailer fees. However, the answer was “yes” when I asked further if they received bonuses based on their mutual fund business. And while some hourly based brokers receive no commissions, trailer fees or bonuses, they may receive a referral or finders fee. For example, if they send you to a particular investment salesperson, they my receive a one time payment from that salesperson, often based on the amount of sales they make to you. When I was operating my accounting business, I was once offered 25% of a life insurance agent’s first year commission for any referrals if the agent made a sale that exceeded $x million…he found it hard to accept that I said no because I thought it was unethical (and at the time, it was a violation of my accounting code of conduct).
For more about fees for all types of investment products, and what is reasonable, have a look at this “Fee Tree” by Steady Hand Investment Funds. It is just their opinion, but I think it is reasonable.
Advisors and financial planners who are paid by the hour for helping you and who do not sell products (such as me) should also be asked if they receive any commissions or referral fees if they recommend you to other advisors for product purchases. (I do not.) All professional financial planners will (or, at least, are required by their professional code of conduct to) give you your answer. If they do not belong to a professional organization, you should be concerned about the adequacy of their training, education and their requirement to abide by a code of conduct, which becomes another question to ask them.
If you have a “buy and hold” investment strategy (as opposed to a frequent buy/sell speculative type of approach), the time required by your advisor may be much lower. This is because they are not constantly looking for opportunities for you to make money by buying new promising stocks and selling existing underperforming shares. You only own solid blue chip investments, which typically do not need much monitoring. Consequently, the type and amount of fee you pay should reflect the different effort required by the advisor. Furthermore, if you own a lot of fixed income securities that are only replaced upon maturity, such as fixed term bonds and GICs, monitoring is minimal, and your advisor may get paid by the issuer upon each purchase (e.g. 0.25% of the principal). Hence, maybe you pay no fees on this portion of your portfolio, or a very minimal fee.
Bottom line – understand how much you are paying in fees, what services you are receiving for those fees, and consider what value you are receiving for the cost.
Questions recommended by the Government of Canada
The questions listed by the Government of Canada on their site at https://www.canada.ca/en/financial-consumer-agency/services/savings-investments/choose-financial-advisor.html#toc4, also referenced above, include this quoted piece:
“Ask a financial planner about the following:
- their education and professional experience
- their certification or designation
- how long the firm they work for has been in business
- how long they have been with the firm
- if they or their firm are registered with a securities regulator
- what products and services do they offer
- how they will help you reach your goals
- if they are paid by salary, commission or other fees
- how often you’ll meet
- how they will keep you informed
- references from previous clients
- how they decide on appropriate investments for their clients
- are they licensed to sell any other products
- have they ever been disciplined by a regulator
- have there been any restrictions, terms or conditions placed on their registration approval
- are they currently under investigation by securities regulators in Canada”
Conclusion
Remember, IT IS YOUR MONEY. You worked hard to earn your money and ONLY YOU ARE RESPONSIBLE FOR IT. How will you replace it if you suffer investment losses? You need to take full responsibility for your decisions, and knowing the answers to these questions is one way to help you understand a small piece of the investment world. If your advisor is not forthcoming, maybe they are not putting your best interests first, and you should get a second opinion. And if they disagree with my opinion, I would be pleased to have an enlightening discussion with them – I am always interested in learning.
Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum