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The most important investment decision you'll ever make (Part 3 of 4)

June 20th, 2013 by

Part 3 of a 4-part series on weighing whether to become a DIY investor or partner with an advisor


Having discussed the benefits and costs of doing your own investing in our previous article, this week we will discuss the merits and drawbacks of working with a financial advisor. It’s unsurprising that many of the disadvantages of DIY investing are the advantages of working with an advisor, and vice versa. The difference makers - as always - are your abilities, personal preferences, lifestyle, budget, and perception of value. We will only touch briefly on the subjects of advisor compensation and the different types of advisors here, but will explore them in detail in future articles.

Discretionary vs. Non-Discretionary Management: Who steers the ship

Although there are five different categories of advisors, it is only necessary (in the context of this article) for you to understand the difference between discretionary and non-discretionary investment management. Historically, the traditional advisor relationship for the everyday investor was non-discretionary, meaning that you either had to call your broker with instructions about what to buy/sell, or your broker could “solicit” a trade by calling you with an idea of their own. Either way, the ultimate decision was still yours; you just paid a pretty penny for it. Mutual funds, which are how most Canadians invest, are typically sold on this same non-discretionary basis.

Until fairly recently, discretionary investment management was something reserved for your pension plan (if you’re lucky enough to have one) and large institutions. As the name implies, the manager responsible for the portfolio uses their own discretion to make buy/sell decisions as opposed to seeking approval from the client for each trade. Normally the client and the manager sit down to establish an investment policy statement (IPS) which sets out the ground rules for the portfolio, and the manager takes it from there. There has been a trend in the past 10-15 years where discretionary portfolio management has become more available to individual investors with smaller portfolios. It’s still a fairly exclusive world however, as only a tiny fraction of those branding themselves “financial advisors” have the education, experience, and credentials to be registered as discretionary managers, and their investment minimums are rarely south of half a million dollars. Still, for some of our fortunate readers, this may be a valid option.

The advantages of choosing an advisor

  • Free your time: Having an advisor handle your investments means more time for the things in your life that really count – family, friends, travel and leisure. If you’re still working – especially if you’re in your peak earning years, chances are your time is more valuable doing what you get paid for than trying to play investment manager, but only you can decide if that’s really the case.
  • Free your mind: Being constantly reminded about what’s happening with your investments, and having all those extra decisions to make can take its toll on your peace of mind. Often the investors with the best performance are the ones who leave their investments alone and let the market do its thing (with the right course corrections over time). Money is also a leading cause of trouble between couples. Having an advisor act as a third party in your relationship can help mediate different “money management” personality types. If one of you is more conservative than the other when it comes to investing, an advisor can help you both understand risk and reward balance. Think of an advisor as a mediator and an educator who can alleviate the stress of investment management in your relationship.
  • Excellent execution: Portfolio managers and some more knowledgeable advisors know how to navigate the ins and outs of the market better than you likely could by yourself. They often have access to forms of trading and foreign exchange that are more cost effective than anything available to individuals. Experience and familiarity with market cycles, today’s economics, and a depth of knowledge of investment vehicles means that an advisor is likely to have a more well-rounded view of the big picture and how your investment goals fit inside it. Just because some advisors aren’t very insightful doesn’t mean there aren’t some great ones out there.
  • More than just investments: Well-rounded investment advisors are also likely to have backgrounds in aspects of wealth management that extend beyond the realm of investments. A Certified Financial Planner (CFP), for example, will not only help you build and manage an investment portfolio, but can also advise you on ways to cut your tax bill, and build a well-rounded financial plan. So while you may be a great stock picker, there’s much more work involved in achieving and maintaining financial independence.
  • Someone to watch over me: When doing your own investing, only one partner in a couple tends to know what’s going on with the investments. This means the burden is on them to keep a constant watch on the whole world’s economy, not to mention following each sector, country, or company they might be invested in. If they’re not available to sit in front of a computer because of unexpected illness, or something a bit more fun like an extended vacation, today’s volatile markets can sideswipe even the most carefully constructed portfolio in the blink of an eye. While some of today’s advisors are really just asset gatherers (sales people) who sock your money into investments and ride the trailer fees, the new generation of discretionary managers tend to take a more active approach to safeguarding your portfolio - keeping a lookout on your behalf, and taking swift action when needed.

The downside to choosing an advisor

  • Handing over the reins: With discretionary investment management you work with your advisor to establish the boundaries and rules for your portfolio, but from there you must be open to their methodology because the portfolio will largely be hands-off for you. This is only a disadvantage if you want the control. Working with a non-discretionary advisor offers more control in that you must approve or reject each investment, but many advisors employ the use of “managed money”, where they hire discretionary mangers on your behalf, or have a particular method by which they make their portfolio recommendations. The degree to which your broker will be open to your meddling in their investment style varies widely, so be sure to ask before you hire an advisor if you think you’ll have the occasional urge to grab the wheel when the road gets bumpy. We will cover this subject in more detail in the fourth and final part of this series when we discuss the merits of combining investment advice with DIY investing.
  • The cost of advice: We’ll be bringing you a dedicated article on understanding advisor compensation, but suffice it to say that no one works for free, and there is a very big range in the fees, commissions, etc., that advisors charge for their services. If your portfolio is in the six to seven figure realm, the collective cost of advice (plus the cost of the investments recommended) should start (in percentage terms) with a 1, but sadly it often starts with a 2, 3, and sometimes an even bigger number. Canadians pay on average 2.5% for mutual funds. In a world where equities return low-single digits and interest rates barely keep pace with inflation, you simply cannot afford to over-pay for investment advice unless your manager/adviser has a knack for adding (consistent) alpha to your portfolio. Saving on fees is one of the main drivers of DIY investing, but since most people still opt for the use of an advisor, be aware that fees have been falling steadily over the past 10-15 years, and there any many choices available to you. The trouble with many investments, chiefly mutual funds, is that it’s often very difficult to understand what fees you are actually paying your advisor. By 2016, new regulations promise to level the playing field and provide crystal clarity to Canadians so we can make better decisions in this area.

The ugly side of hiring an advisor: Thieves of Bay Street

While cases like this are rare in the grand scheme of things, some “advisors” are really thieves in disguise. They promise you the world, conning you into believing they have the “perfect” investment vehicle that will earn you a healthy return, only to leave you high and dry - sometimes snatching your life savings from you in the process. In fairness, this is a risk that any investor may be exposed to whether they have an advisor or not. Nevertheless, be wary of grandiose claims of “sure things”, promising all upside and little to no downside. Remember that if it’s too good to be true, it is. No investment should return significantly more than other comparable investments. There is always risk in any investment. Furthermore, the greater the return, the greater the risk. This is such a critical concept that it’s worth repeating: There is always risk in any investment. If an advisor you’re considering working with spends little or no time talking to you about the inherent risks of the investment products they offer, move on...quickly.

What to do if you hire an advisor

If you do decide to hire an advisor, the responsibility of investing isn’t entirely off your shoulders. Here are a few things to keep in mind when working with an advisor:

  • Do a background check: Make sure you get a good picture of an advisor’s reputation and past performance. Talk to friends and family who know the advisor and solicit their feedback. You can also Google your advisor’s name to see what they’ve been up to. Also, make sure their firm is large and reputable, and if they’re part of a smaller boutique firm, make sure they utilize a custodian that is well-regarded to safeguard your money. You should make sure your accounts will be protected by The Canadian Investor Protection Fund (CIPF), and that your advisor is properly registered with the provincial securities commission, or a self-regulatory organization that can provide you with some recourse in the event of unscrupulous behaviour by your advisor. If you live in Ontario, you can check the regulatory history and registration standing of both your advisor and firm. If you’re from any other province, you can check here.
  • Understand what’s happening with your money: Meet with your adviser regularly, and inform them immediately of any change in your financial circumstances such as a change in your family, change of employment, adjustments to your retirement timeline, or a need for liquidity (converting large amount of your portfolio to cash). Also check in with your advisor periodically to ensure that your portfolio design is meeting your investment objectives, and just to be safe, once or twice a year try to reconcile what your advisor tells you with your account statements.
  • Insist on full disclosure about fees and your investments: Many advisors are compensated directly or indirectly by the institution whose products they’re selling you. The problem is, these fees are often hidden, but come out of your pocket anyways. Fortunately, new regulations will phase in between July 2013 and 2016 that will require investment dealers to disclose the exact amount of compensation your advisor and the firm are being paid, either directly by you or by the issuing institution. The rules also require much more comprehensive reporting about your total account performance, going back to when you first became a client. All of this is already available today from the very best advisors, and has always been required of portfolio managers.

If after reading this article you decide that hiring an advisor is an avenue you’d like to pursue, take the time to learn the four things a financial advisor should do to earn your trust.

Jun 25 2017 12:31pm

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