It’s one of the things we are most afraid might happen to us. We go to great lengths to avoid it. And yet we do it all the same: We choose the wrong financial advisor.
Partly, it’s because very few of us really want to do the work to understand all the details of money management. We don’t want to study investment portfolios and insurance policies and mortgage contracts. In a wiser, more self-aware society than our own, financial planning would be standard high school curriculum.
Perhaps this is why most of us do the minimum required to take care of our money, and only when we are more or less forced to do so. Buying a house? Then I guess you’ll have to slog through the mortgage process, signing off on a contract worth hundreds of thousands of dollars with white knuckles.
Your employer has an RRSP-matching program? Drag yourself through the list of investment options with a little devil on one shoulder telling you to pick the “aggressive” option and a little angel on the other shoulder warning you not to blow it.
Why is it that we so rarely leave these experiences feeling safe, happy and confident?
There are about 200,000 advisors of various sorts across Canada. Think financial advisors, insurance agents, mortgage brokers and the like. Few of them are truly able to work in your best interests. It’s not because they are bad people. The problem is how the industry itself is structured. Almost every one of these advisors relies on sales commissions for their livelihood.
This means your investment advisor has a financial incentive to put your money in the highest-fee investments, and to lock you into things like RRSP accounts that make it harder to take your money back if you need it. Your insurance agent is motivated to sell you the biggest, most expensive policy. Your mortgage broker will pocket more money if you pick the largest mortgage at the highest rate with the most restrictive conditions.
You might be wondering who gets paid to figure out the objective best thing for you? The lowest cost for you? The optimal choice for you? The answer is almost nobody. The way the industry works, advisors get paid to win your business, not to recommend the absolute best course of action for you and your family.
You may protest that, “I love my financial advisor,” or, “There’s no way my person at the bank would hurt me,” or even, “I get advice from a friend or family member, so surely they’re working in my best interest.”
Let’s look at the economics of being a financial advisor. It would not be out of the ordinary to spend a month running seminars, making phone calls and having multiple meetings for an advisor to land one new client. What is a month of effort plus costs like marketing and dinners and support staff worth? $5,000? $7,000? $10,000?
In order to survive, the advisor must recover their costs, plus a profit. They’ll often do it by putting you into mutual funds. Your mutual fund might earn 9% per year before fees, but you’ll never actually see that number. The mutual fund company will keep 2% per year and your advisor will keep roughly 1% per year. As far as you know, your fund only earned 6% per year.
Perhaps 6% per year is good enough to get you to your goals and everyone goes to bed happy. But you need to realize that the 3% per year you pay in fees, plus the lost growth on that money, could cost you literally hundreds of thousands of dollars in fees over your lifetime.
The point is, you don’t need to be a bad person to fall into the trap of excessive fees. Even if we’re talking about your cousin or an advisor you’ve trusted for years, money has influence. They have a family to feed too. It’s especially tricky when these fees don’t even look or feel wrong given the norms of the industry. It’s just “business as usual.”
Now, let’s say you’ve found an advisor who’s willing to trim their usual commissions and cut you a deal. That’s good. What’s still missing is the ability to provide you with the correct advice.
For example, your advisor is doing a great job with your investments, but as an investment specialist, he or she did not make insurance part of your plan. Down the road, you get sick and can’t work for a year, or maybe your spouse passes away, and you end up having to raid your investments and push your retirement back 10 years.
Or perhaps your bank is letting you invest in their mutual funds where you’re making five or six percent, while at the same time having a balance on your credit card where you’re paying them 19 percent.
Heck, your advisor can make a mistake as simple as having you invest a sum of money every month, but not optimize and update your plan regularly so that when you get to age 65, you simply don’t have enough money to retire. What are you supposed to do then?
With few exceptions, advisors are not financial engineers or mathematicians. We usually start working with one for emotional reasons (i.e. “I like this person”) rather than rational ones (i.e. “This person has designed an airtight financial plan for the rest of my life”). The reason we make this trade-off is because we ourselves are not experts, and we assume the advisor is capable of more than they really are.
In general, an investment advisor simply can’t calculate your optimal savings amount every month of your life. An insurance agent can’t make sure that your insurance protection is integrated with the projected growth of your investments. People who provide mortgages and other debt usually know nothing about investments or insurance (except when they try to get a bonus commission by selling you overpriced mortgage or creditor insurance).
The people in the executive suites of the biggest banks and insurance companies are well aware of the problems with the commissioned-salesperson-as-advisor business model. Everyone is looking to the rise of new alternatives that use technology to reduce costs and improve outcomes for Canadians.
The truth is, financial advisors are at a huge disadvantage. Their financial incentives generally conflict with yours, and they almost never have the knowledge or technology needed to make recommendations that are truly in your best interest anyway.
In the final analysis, there really isn’t a “right” advisor that you can turn to. Almost every advisor is the wrong advisor.