Q: My financial advisor has most of my money in equity mutual funds and I'm losing money. I suggested he put my money in index funds so I won't lose as much. He disagrees with me. What should I do?
Asked by Anonymous, London, ON
There are a couple of issues here.
First of all, your financial advisor should have spent some time with you to determine your needs, goals and personal risk tolerance and then recommended an appropriate asset allocation based on these factors. In simple terms, asset allocation is determining what percentage of your funds should be in equities vs. fixed income investments. The more equities you have, the higher the potential return, but the more volatility.
Once an appropriate asset allocation is determined, the next step is selecting the investments. Just like mutual funds, index funds can be investments in all different asset classes: not just equities.
Index funds are considered “passive investments”. They are constructed to invest in the broad market. For example, a Canadian equity index fund based on the S&P/TSX 60 is composed of the 60 largest companies listed on the Toronto Stock Exchange, held in proportion to the relative size of each company.
Many mutual funds are actively managed, meaning that the managers select each stock based on their own analysis. This can mean excluding many stocks and holding more of one stock over another, with no relation to the size of the company.
Proponents of active management feel that good active managers can add value through increased returns and by reducing risk. Proponents of index funds point out that that a great many active managers fail to do this. In addition, the costs of index funds are much lower than actively managed mutual funds.
A good financial advisor will take the time to educate their clients as part of the investment process. It may be that your advisor has tried to do this, but perhaps his/her communication style doesn’t work for you.
It also sounds as though you are uncomfortable with the current equity exposure of your portfolio. It may be that your advisor did not do a good job in determining an appropriate asset mix with you or it may be that your risk tolerance has changed.
It may be that you need to find another advisor. A good advisor will:
- Take the time to review your current financial position, goals and risk tolerance.
- Set a target asset allocation with you, ensuring you understand the potential risks, as well as returns.
- Communicate with you in clear and understandable language and address any questions you raise.
- Meet with you at least once a year.
If your financial advisor hasn’t followed these four key points, I highly recommend that you find one who will.