Financial Literacy: Three Answers

how to calculate compound interest

The Wall Street Journal (WSJ) published an article a few years back,  a three-question test of financial literacy (which, of course, unleashed fury in the comments on financial literacy – or lack thereof – in North America.) But what I did notice was that while the WSJ provided the answers, no one took the time to explain why the answers are the answers

 

Which I think is not so great because if you didn’t get all or any of the answers right, you might feel not-very-smart and that’s not allowed here on The Money Coach.

There are no stupid questions, just an industry that is most profitable when financial literacy is not part of the equation.

Let’s do this! The first question was: 

1. Suppose you had $100 in a savings account, and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?

A. More than $102

B. Exactly $102

C. Less than $102

The answer to this lies in understanding the concept of compound interest. You can click that for the Wikipedia definition, but here is mine:

If you have $100 and put it in a savings account that pays 2% per year, at the end of the first year, you will have $102. (100 x 2% or 100 x 1.02 = 102). So that is after one year. The question asks how much you will have after five years. 

Working this out from day one: 

Year one: 102 x 1.02 = $102

Year two: 102 x 1.02 = $104.04

Year three: 104.04 x 1.02 = 106.12

Year four: 106.12 x 1.02 = 108.24

Year five: 108.24 x 1.02 = 110.40

After five years, you would have $110.40, which is more than $102. 

The answer is A.

If you break this down, the magic of compound interest is that not only does your original amount (in this case, $100) earn interest every year, but so does your year-on-year interest. In the second year, your $2.00 of interest (from the first year) also earns 2% interest. And then, in year three, your $4.04 is earning 2% interest, and you get the idea. 

A common (and understandable) mistake is to take the 2% per year and multiply by 5 (the five years in the question), which is 10%, and so $100 x 10% is $110. However, this is not correct. When your interest pays annually (once every year), your interest payment becomes part of your original amount (so at the end of year one, $100 because $102). And so, for each subsequent year, your new capital amount is higher than the year before.  

Got it?

Answers to questions two and three are here and here

Thousands of Canadian Investors, Just Like You, Are Being Robbed of Investment Returns

In the May 20, 2017, Report on Business (Globe & Mail), there is a front page article by Clare O’Hara, Wealth Management Reporter, titled:

No advice, still a price: Fund fees draw fire

…an article which continues to expose not only how high mutual fund fees are in Canada, but how the compoicated fee structure continues to be exploited by the financial industry.

How?

As I’ve written in the past, mutual funds in Canada are notorious for hidden, high, and complicated fees. And part of the complicated part is that there are different levels of fees for the same mutual fund.

You might ask, “Nanci, are you telling me that if Janet and I purchase the same mutual fund, she could be paying 0.75% and I could be paying 2.25%–for the exact same investments?”

And that is exactly what I am saying.

What gives?

The justification (from the mutual fund industry) is that the different levels of fees are to provide compensation to any salesperson or financial advisor for the expert financial and investing advice they might provide you.

To be clear, it is the Series A version of any mutual fund that allows this high fee that is for financial and investing advice.

Again, this is what the industry calls embedded commissions, but what I (and many other financial writers) call hidden fees.

“Nanci, are you telling me that if Janet and I purchase the same mutual fund, she could be paying 0.75% and I could be paying 2.25%–for the exact same investments?”

And what was the point of Ms. O’Hara’s article?

That 83% of mutual funds sold through DIY brokerage houses (i.e. NO advice given or provided) are Series A mutual funds.

Do you understand what this means?

The brokerage houses are enabling you to purchase high fee mutual funds, up to 2% higher, even though you are not receiving any advice from them. And you know from Day 9, that 2% in additional fees can be devastating to a portfolio, costing you upwards of 30% of your annual income in retirement.

For what?

Nothing. Absolutely nothing.

Ms. O’Hara reports that of the 30B in mutual funds held at discount brokerage houses, 25B remain in fund series that bundle (aka hiding) an advice fee within the product.

Even though no advice is ever given.

At even just 1% in extra, hidden fees (although I suspect it is closer to 1.5%), that is $250,000,000 in fees that they are not entitled to because they did not earn it.

Once again, your money, in their pocket. For nothing.

At the risk of sounding like a broken record (apologies to those of you who do not know what records are!), are you really ok with, from age 65 – 100, having an income of $70,000/year instead of $100,000/year?

Just to enrich the financial industry? Are you that generous?

All right. So why/how is it even possible for discount brokerages to sell Series A funds? If they do not provide advice, ever, how is it possible that 83% of the mutual funds they sell include embedded fees for providing advice.

Good question. I don’t have an answer except, “Welcome to Canada where the financial industry–including banking, investing and insurance–is not your friend.”

I commend Ms. O’Hara for bringing this information to light. I was aware of the problem of financial advisors selling Series A mutual funds, and then not providing much advice if any. However, I did not realize that discount brokerages — who are not even able to provide advice — are permitted to sell the Series A version of mutual funds.

What a mess.

I will wrap this blog post up with a comment that rather than trying to wade through the overgrown weeds that are mutual funds in Canada, think about purchasing low-fee index funds or ETFs.

It really is that simple.

PS. You are one decision away from leaving the mutual fund industry in the dust. Vote with your dollars and move your money out of mutual funds once and for all. If you are interested in a step-by-step MasterClass on exactly how to do this (not just why), check out my online course http://zerotoportfolio.com.

You won’t be disappointed.

5 Questions To Ask Your Financial Advisor

Welcome to the third (and final) part in our series on Financial Advisors.

Today, I want to provide you with five questions that you can ask your financial advisor. If you don’t have a financial advisor, you can use this questions when interviewing for a new Advisor (ask for the answers based on an average balanced portfolio under his or her management. It’s not the specific answers that are important, but whether the Advisor is able or willing to answer the questions).

1. What are the total costs and fees associated with my account?

If you can believe it, and unless your Advisor believed in transparency, up until recently this was one of the most difficult questions to get an answer for. I say up until recently because for decades the industry has lobbied (successfully) for a compensation structure that keeps the majority of investment fees hidden from investors.

And yes, that’s you.

It was not uncommon to ask this question to an Advisor and receive vague answers like, “Don’t worry about that, it’s the returns that matter,” or, “No need to concern yourself with that, it’s the mutual fund companies that pay my salary.” Worse, some Advisors—in an attempt to ensure the question is never asked again—will shame you into having asked the question, implying (or outright stating) that you have disrespected them but asking a question that insinuates they are untrustworthy.

No, I am not making this up.

However…somebody somewhere seems to have championed investors’ rights because as of December 2016, all investment statements must state the full costs to the portfolio (including the hidden ones) on each monthly statement. As you can imagine, the industry fought this tooth and nail.

(yes, there is actual a statement from Association CEO and President, Greg Pollack, to have all 12,000 Advisors in the club have their clients call their provincial legislators and demand that their mutual fund fees stay hidden, and that they are terrified they will suffer if they know how much they are paying in mutual fund fees.)

The last part I agree with.

On that note. I have a friend who told me for years that she had over $1,000,000 invested with a Financial Advisor who she trusted implicitly, who had provided decent advice and good service, and who was a family friend. Also, that this Advisor had reassured her several times that her annual fees were 1.0% Which is great.

But on her January 1, 2017, statement she saw that, in fact, she was paying almost 3.0% because yes, she was paying the 1.0% investment management fee and 2.0% average MER on over well over $900,000 of mutual funds.

Did the Advisor lie? No. My friend’s annual management investment fees were 1.0%. The Advisor simply omitted to tell my friend that the mutual funds recommended to her had MERs of 2.0%.

I’m sure she just forgot.

I cannot even imagine the opportunity costs to my friend’s portfolio on 1% vs. 3% on a $1,000,000 portfolio over 10 years. (hint: at 7% average annual return, it’s $328,564)

What a lovely family friend!

Bottom line: While the new legislation will provide with the total charges and fees associated with your account, I think this is still a good conversation to have with your Advisor—even just to see if s/he is open to the discussion.

2. What is my asset allocation?

We will cover asset allocation in an upcoming lesson, but essentially, it is your split between stocks and bonds (or conservative vs. risk). Any decision as to asset allocation should have (and I mean should, not could) a conversation around time horizon and risk tolerance, and so if she tells you either a) she is not sure or b) what your asset allocation is without you having providing her this information, you should probably think about finding a new Advisor.

Bottom line: Asset Allocation is one of the single most important decisions an investor will ever make. If an Advisor is glossing over it, you are in the wrong place.

Note: You will find an entire module on asset allocation in http://zerotoportfolio.com.

3. What is my 1 year, 3 years and 5 years rate of return?

You would think this would be something that would be provided to you on a regular basis, but no, there are still many brokerage firm statements that do not include this information. Your Advisor will have firm-provided software that calculates this on a daily basis and so there is no reason that you should ask and not receive this information.

Bottom line: You should not only have access to the rates of return on your portfolio(s) for any given time period but also whether your portfolio is ahead or behind of the benchmark index. (i.e. is your portfolio doing better or worse than if it was invested in a passive index fund or ETF.)

4. What is the current dividend yield on my portfolio?

We will have an upcoming lesson on dividends but consider this: From May 1980 to May 2017, the S&P 500 returned 6.833%, not including dividends and 10.046% including dividends*.

Bottom line: Dividends are important, and they matter. Unless you have made a conscious and explicit choice to exclude dividends from your portfolio, it is irresponsible (in my opinion) to not optimize a portfolio to include returns from dividends.

5. Are you a fiduciary or are you held to a fiduciary standard?

The fiduciary standard of care basically says that an Advisor must put your interests before his or her own. I know. You just fell off your chair right. You were probably thinking that all Financial Advisors would have to put what is best for their client (i.e. you) before their own interests (say, putting you in a higher risk investment that is not appropriate for you, but the hidden commission was just so high he couldn’t resist!). But no, there are still huge swaths of Financial Advisors in Canada that are not held to a fiduciary standard.

And yes, of course, the financial industry is fighting this one as well.

There are other questions you could be asking your Advisor as well, related to tax planning, estate planning, insurance, etc. but the above questions would be my top five questions related to investment management.

That concludes this 3-part series on Financial Advisors, I hope you found it useful! I will be back in your inbox tomorrow with core lesson six: Bonds.

Series Links:

Part One
Part Two
Part Three

*all dividends reinvested; source https://dqydj.com/sp-500-return-calculator/

PS, if this is feeling overwhelming to you or you have decided that working with a Financial Advisor is not for you, don’t hesitate to take a look at my online course, Zero to Portfolio, An Investing MasterClass.

The course is 100% online self-study and is structured as over 10 hours (and 10 modules, 30+ lessons) of HD video, providing you with everything you need (and nothing you don’t) to create and manage a successful investment portfolio. Click here to learn more!

Financial Advisors and YOUR Money

learn to invest on your own

In part one of this three-part series, we looked at the math behind why some Financial Advisors have a minimum account requirement of $250,000 (or more), and also three reasons why (most) Advisors might not be the experts you believe them to be.

If you missed that post in the series, you can find it here » https://themoneycoach.com/fa1

Today, in part two, I want to look at the various levels of Financial Advisors in Canada, because just like lipstick and mascara (LOL), not all are created equally!

OK, in no particular order:

Bank Financial Advisors

These Advisors are employed by the bank and will receive a salary plus a small commission to push you toward bank products. For example, if you have a cash balance in your account of several thousand dollars or more, a teller (who will also receive a small commission), might mention it to you and ask if you would like to see a Financial Advisor at the Branch.

If you agree, you will most likely see someone that has limited training or knowledge on portfolio management strategies and will advise you to purchase a basket of high-fee mutual funds offered by the bank.

Bottom line: Never a good option.

Mutual Fund Representatives

These Advisors are contractors who work for a specific mutual fund company (i.e. Fidelity, Dynamic, AGF, etc.). They work their own hours, most often from a home office and are usually more than willing to meet you at a place of your convenience.

My first experience with investing was a lovely woman named Donna who worked for Dynamic Mutual Funds. Despite the fact I only had a few thousand dollars to invest, she was always willing to meet me at home or a cafe by my office for lunch. I did not realize it at the time (I was 18!), but she was paid to sell only Dynamic Funds. I remember the only time she became upset with me was when I wanted to purchase a mutual fund from Fidelity that had been recommended by a friend.

As you might guess, the fees were high; between 2% and 3%* for equity funds. In fact, Donna was so successful that her husband quit being a fisherman to become her partner and also sell funds for Dynamic. So yes, not always a lot of training in mutual fund reps.

Bottom line: Never a good option.

Financial Planners

In general, there are two types of Financial Planners: commission-based and fee-based. In the first scenario, the planner will provide you with a comprehensive financial plan that could include investment recommendations, tax planning, estate planning and insurance advice. The Advisor does not charge a fee for the meeting or the plan but does receive commissions or referral fees for the products recommended to you.

Can you see a pattern here?

I would never choose to see a commission based planner because I could not be sure s/he was recommended products that were right for me, or even better for the downpayment on their new country house.

Bottom line: Avoid working with any commission based Advisor or Planner

Which brings me to fee-only planners, which I think are great! With fee-only planners, you receive a comprehensive financial plan, one that should see you through years, for a one-time up-front fee. Depending on your situation and the planner’s rates, this could be between $500 and several thousand dollars.

Why do I love upfront fees?

In Day #12, we looked at an example where the cost of hidden fees was, over the long term (i.e. 20 – 30 years) devastating to the portfolio. And so yes, of course, I would rather pay a one-time fee of $2,500 (that is also most often tax deductible!), that hundreds of thousands of hidden fees and opportunity costs over 20+ years.

Bottom line: Always (in my opinion) a good idea.

Caveat: Commission-based planners love to bash fee-only planners. They will find examples of unethical fee-only planners that have figured out a way to charge both an up-front fee and commissions on recommended products, usually insurance and referral fees for professional recommendations. And so they write posts like, “Beware of Fee-Only Planners!”

But this is dumb. It is like saying, don’t go outside because you might get hit by a car. The trick is to look both ways before you cross the street. In my opinion (and experience) there are far more ethical fee-only planners than unethical (and not sure I can say that about commission-based planners).

If you are looking for a directory of pre-screened (trust me, it’s tough to get on this list) fee-only planners in Canada, check out the MoneySense directory: http://www.moneysenseapproved.com/find-an-advisor/

(and no, of course, I do not receive any referral fees on that list)

Portfolio Managers/Wealth Managers

This group of Advisors will charge between .75% and 1.5% to manage your assets. Which is to say, if you have $500,000 (which as we discussed yesterday, you will need to get into this club), you will pay roughly 1% or $5,000 each year for investment management and (possibly) financial planning.

I have worked as an Assistant and Associate Financial Advisor for a few top wealth managers, all of whom were highly educated in portfolio management and financial planning, and I can tell you, even at this level, there are some atrocious and unethical Advisors.

But? Also some of the best, most ethical, professional and competent Advisors you could imagine. Bar none.

(yes, I was in Victoria for the first 28 years of my life)

Bottom line: A great option if you have amassed a certain (high) level of investible assets, but you have to do your homework! You have to ask questions (we will cover this in a future lesson), and you
absolutely can not enter the client/Advisor relationship with blind trust. It is buyer beware when choosing a professional wealth manager.

Insurance Advisors:

This lesson is long enough, and so I will just say, if you need insurance, visit an insurance person. If you need investment advice, don’t. It is that simple. Insurance salespeople are often licensed to sell hybrid insurance/investment products, but (as you can probably guess!) the fees are ridiculously high on these overpriced and often unnecessary products (i.e. segregated funds**).

Bottom line: No.

So what’s a girl to do? If you do not have $250,000 or more (and you don’t want to pay high fees) your options are far and few between in finding an Advisor.

My recommendation?

Work with Wealthsimple (managed) or open an account at Questrade (DIY) and manage your own portfolio.

It is not as difficult as you might think. Trust me.

And that wraps up today’s lesson! I hope you feel you know a little bit more about the Financial Advisor landscape in Canada than before you read this lesson.

I will be back tomorrow for the third, and final, installment in our three-part series on Financial Advisors.

Series Links:

Part One
Part Two
Part Three

*pricing pressure from competition (specifically from firms like Wealthsimple, have brought the highest MER at Dynamic down to 2.0%)

**there are rare cases when it makes sense to purchase segregated funds (i.e. seg funds offer creditor protection in the event of bankruptcy or other creditor claims, and so, in certain circumstances, can be useful for business owners or Directors)

Ps. If you are looking for more information, I cover mutual funds, ETFs, segregated funds and Financial Advisors in-depth in Module Three of Zero to Portfolio, An Investing MasterClass.

How Are Financial Advisors Paid?

how are financial advisors in Canada paid

We are going to spend the next three blog posts on Financial Advisors—because yes, they are that important to the conversation.

First, I’d like to stress that just as you or I expect to be compensated fairly for our products or services, financial advisors as well, deserve and need to get paid.

Second, I will be the first to agree that there are many, many excellent, qualified and devoted financial professionals in Canada.

Third, anyone who has spent a decent length of time working in the industry would probably agree with the statement that upwards of 70% – 80% of financial advisors in Canada are not the experts you might believe them to be.

Why?

Most financial advisors are in fact sales persons for a bank or a broker; their responsibility is to their employer and not to you.

The current structure of compensation for financial professionals—specifically as to commissions and trailer fees, creates a landscape ripe for high, hidden and complicated fees.

The requirements to become an investment representative are so low ($375 course; pass mark 60%; no academic prerequisites) that there are a fair number of people representing themselves as experts, when in fact, they may not have more than one or two courses on the subject.

How do investors pay wealth managers?

The generally accepted fee for wealth management is 1% of assets under management. Meaning, if you have $1,000,000 with a wealth manager, you can expect to pay (give or take) $10,000 in fees to have those funds managed professionally. This 1% charge will often include input on any estate planning, collaboration with your accountant, insurance advice, etc.

Essentially, you are being a supported by a true financial professional.

Let’s keep moving forward to look at how a wealth manager is paid:

Hypothetically, let’s assume that our financial professional—let’s call her Christine—would like to earn $250,000 before taxes. She works 60 hours a week, passed all her courses, spends weekends reading Portfolio Management journals, and she provides her clients with superior investment management and exceptional client service. Christine deserves to get paid.

Now, Christine will have to split the 1% wealth management fee with her firm— most often half of the fee will go to the employer firm (i.e. Merrill Lynch, TD Wealth Management, Wood Gundy, etc.) to cover the cost of an office, assistant, marketing, and related expenses.

Summary of Christine’s situation: 

  • To earn $250,000/year, Christine needs to manage $50,000,000 (50MM x .005)
  • Christine works 200 days per year
  • After office meetings, portfolio management, and research, on average, Christine can see no more than three clients per day
  • Clients expect to see Christine approximately three times a year (some semi-annually and others Quarterly).

If we look at the math, and we take into the account the maximum number of clients that Christine can see, without sacrificing her ability to service them, it is 200 clients.

  • 200 days a year, with ability to see three clients per day is 600 meetings per year (200 x 3)
  • clients need to be seen three times per year, so the maximum number of clients Christine can have at any one time is 200. (600 / 3)

What does this tell us?

It tells us that with the necessity to have $50,000,000 under management, and the maximum number of clients 200, that the average account balance needs to be $250,000.

And this is why if you have less than $250,000 it is often hard to get access to high-quality wealth managers.

So where do you go?

According to the statistic of there being 1.138 trillion dollars in mutual funds in Canada*, you go to a bank or a broker where you will see a sales person who will sell you bank or brokerage products, most often mutual funds with an average MER of 2.0% – 2.5%.

And if that is not clear, yes: You are paying twice as much for half the service.

I am not sure if it is right or wrong, fair or unfair, but I do know it is the current state of affairs in the Canadian investment industry.

So what can you do if you have under $250,000 in investable assets?

You can learn to invest by yourself. There has never been a better time to learn to invest on your own. Why? Because technology has left no industry untouched, including the investment industry. There is absolutely no reason, none, zero, that you should be paying over 1% for management fees. And that means no more mutual funds.

It means self-managed ETFs (Questrade) or looking at some of the great auto-investors in Canada (Wealthsimple).

I will talk more about Questrade and Wealthsimple in an upcoming blog post but over the next few days, you can expect more posts in this 3-part series on Financial Advisors.

*as of January 2017

Series Links:

Part One
Part Two
Part Three

ETFs—What the Heck?

ETFs What The Heck
A FEW WORDS ON ETFS

A few years ago, at age 42, I started gardening.  I know, a bit of a late bloomer (pun intended!). I read a few blogs, bought a few plants, something called Miracle Gro, a big shovel and a small shovel. And then I started digging. After two full days, I stood back and admired my work. Not only was my garden going to robust and beautiful, but in doing it all myself, I had saved a ton of money.

I was quite proud of myself. Maybe even a little bit smug. 

But as the weeks past, very little turned out as I had expected. Some of the plants died. Others grew so well, they began to crowd each other and my hosta beds began to resemble some sort of home-and-garden Game of Thrones episode. The squirrels used my echinacea flowers as their own personal salad buffet and all the blooms fell off the hibiscus. I read more blogs. Was I overwatering or under-watering? If the label said, “part shade”, how much sun was enough sun?

And why did my neighbours garden look so much better than mine?!

WHY AM I TELLING YOU THIS?

Because while I was digging and sweating, and pulling and patting, watering, and shaking Miracle Gro—bursting with hopes and dreams and expectations—I failed to recognize two important facts:

  1. I did not have a plan, and;
  2. I didn’t know what I didn’t know

This is important because now I am going to tell you about ETFs.  And ETFs are pretty cool. But first I need to step back and talk about diversification.

Diversification is the idea of not putting all of your eggs in one basket, or in the case of investing, consider the following examples:

  • 1000 stocks instead of one stock
  • ten countries instead of one country
  • bonds and stocks instead of just stocks
  • stocks and bonds instead of just bonds
  • micro/small/medium/large company stocks, instead of just big companies

COOL?

Er, if we only have $1000 to invest, how do we buy 1000 stocks, ten countries, bonds and stocks and the stocks of virtually every size of company?!

Well, there are two ways to do this:

  • mutual funds
  • exchange traded funds (ETFs)

First, both offer exceptional opportunities to diversify your portfolio. If you are looking for asset allocation (cash, bonds, stocks, Real Estate, Commodities) you will be well served by both mutual funds and/or ETFs.

That said, there are two fundamental differences between mutual funds and ETFs:  active management vs. passive management, and fee structure.

ACTIVE vs. PASSIVE

In the decades before the computer (yes, I can remember…) if a mutual fund had the mandate to hold 1000 stocks, a Portfolio Manager, and his or her team would have to research the Universe of available stocks and choose the individual 1000 stocks for the portfolio. This strategy—inclusive of human decision-making—is called active management. And for years, it was the only game in town.

Fast forward to 2016, and we are now in the midst of a technological shift that is disrupting virtually every industry that touches our daily lives. The investment industry is no exception: the last decade has ushered in with it the rise and proliferation of low-cost and easy index investing—dramatically altering the investment landscape.

What is an index?

You know how when Global TV says, “78% of Canadians think Justin Trudeau is doing a good job,”?  We understand that the polling company did not call every Canadian. We accept that they called a segment or cross section of Canadians and that this cross-section of Canadians can be considered a proxy for most Canadians. And so it is the same with stocks (or bonds). An index is a certain number of stocks or bonds that serve as a proxy for the entire market you want to own.  And that index is chosen (probably in milliseconds) by a computer. This investing, by an algorithm, is called passive investing.

FEE STRUCTURE

In general, mutual funds in Canada have an embedded fee structure. Meaning that your fees, which are a percentage based on the total amount of assets you have invested with your Advisor or fund company (i.e. $80.000), are taken by the fund company before your annual returns are reported to you. This annual fee is called the Management Expense Ratio or MER, and it used to pay the operating, sales and marketing, and trading costs of the mutual fund. It is also possible that a portion of the MER is paid to your Advisor as compensation for both financial and investing planning you receive.  MERs vary between fund companies and asset classes (i.e. bond funds will have a lower MER than equity funds), but MERs between 1.5% and 2.5% are relatively standard.

The annual fees for ETFs. Because the computer is selecting the investments in the fund (it is still called a fund, just exchange traded fund instead of mutual fund) and because there is no advice given (and I mean none), you will often see annual MERs for ETFs well under .5%.

Also, it is important to note that while you can easily purchase mutual funds through your bank or an Advisor, ETFs trade like stocks and must be purchased through a self-directed brokerage account. Which means, yes, more time, work and responsibility done by you as a DIY investor.

WHICH IS  BETTER—ETFS OR MUTUAL FUNDS?

There is no one-size-fits-all or black and white answer to this question. Because ETFs offer diversification with low fees, you will often see financial media and bloggers abandon their mutual fund portfolios (and Advisors) for cheaper, leaner do-it-yourself ETF portfolios.

However, in the case of my somewhat failed landscaping project, this decision puts you at risk of finding yourself in a situation where you have no plan and don’t know what you don’t know. And when you realize you are in over your head (or up to your knees), no access to a knowledgeable professional to call and help sort it out.

If you are new to investing, I will say this: There is probably a place for ETFs in your overall plan. Maybe now, maybe later. But like any DIY project or passion, there is a significant time commitment and learning curve to become skilled. And while I confess to being one of those financial bloggers that loves to wave the ETF flag, I will say that having a rock solid plan and good advice beats cheap each and every day.

In the end, I hired a landscaper. I paid several thousand dollars to have my beds restructured and for a plan that included, you know, knowledgeable advice about which plants go where, taking sun shade and eventual size. As I learn more, I rely on my landscaper less. And although one day it is possible that one day I might do 100% of my own landscaping, I have to admit it is pretty nice to have someone else to the heavy lifting.

Ready to learn how to invest on your own?

Visit http://zerotoportfolio.com

OR?

Want to have someone help you with the heavy lifting? Visit MoneySense Magazine’s directory for fee-only Financial Advisors.

Three Investing Myths

investing myths canada

I have heard many reasons women put off starting to invest (or participating more in the management of their portfolios) but the following three are by far the most common.

1. It is too complicated to get started

Years ago it may have been harder to get started, but then this great thing called the Internet came along and the truth is, never before in history has it been easier to create and successfully manage an investment portfolio. If you can buy a few sweaters and a pair of jeans online from the GAP, you know almost everything about getting started with investing. With even just $100/month you can jump online, open an account and set up monthly purchases of well-diversified, low-fee Exchange Traded Funds (ETFs).

Imagine if you never learned how to drive? Would you not regret the freedom it affords you today? It is the same with investing. —Nanci K. Murdock, CFA

Imagine if you never learned how to drive? Would you not regret the freedom it affords you today? It is the same with investing. Take the time to learn the basics today, and in a few years, you will enjoy both freedom and gratitude from your decision.

2. It’s super risky

Someone once told me they would never invest in the stock market because they did not want to lose all of their money. It doesn’t quite work like this. I have found that investors tend to have been overly influenced by their first experience with investing. Perhaps they took a hot stock tip from their Dentist and lost 90% of their investment. And so now, without any further research, they have decided that investing is high risk. With proper asset allocation, you can structure your level of risk to best match your comfort level and tolerance for any losses.

Yes, investments can go down. But if you stick to diversified stocks and bonds, there has never been a time in history that they did not come back up. Education and patience are all you need. I’ll cover the education if you’ll take care of the patience!

3. The professionals know better than you do

While Financial Advisors may have more information than you, hundreds of studies over the past ten years have shown that this knowledge does not translate into higher returns for you. (although those same studies have shown it does translate into higher fees for them!)

I will cover Financial Advisors in another post (because there are some great advisors, and like any profession, including yours and mine, good advisors need to get paid). But please, do not assume that just because you are at the beginning of your investing journey that you need to hand all decisions over to an Investment Professional. I have worked with many women, who after learning the basics of investing, took over managing their own portfolios and never looked back.

If you have not started investing, what are you waiting for? 

Just Found Out How High Your Mutual Fund Fees Are?

mutual fund fees canada

Looking for a next step? 

Many of the people I work with are shocked to learn the true cost of mutual fund fees in Canada. Between the load fees, any DSC redemption charges and the average MER of 2.25% (highest in the world!), fees can leach hundreds of thousands of dollars from your retirement.

Don’t let this happen to you!

If you want to take control of your financial future, the very first step is to determine the amount of fees you are paying for investment advice. Once this task has been done, you have three options:

STAY WHERE YOU ARE

You are satisfied with the level of service you are receiving for the annual fees paid. You have a high six or seven figure account and you have calculated that you pay between 1% – 1.5% annual fees (outside of your TFSA or RRSP!) for a top level of service that includes estate, insurance and tax planning. Congratulations! …and remember your advisor at Christmas.

WORK WITH A FEE-ONLY PLANNER

You could move from an asset based fee structure (paying a percentage each year based on your account value) to work with a fee-only planner. Depending on your situation, a fee-only planner charges you a one-time fee ($1000 – $5000) to provide you with a comprehensive financial plan for moving forward. This plan can encompass everything from investment advice, asset allocation, tax, insurance and estate planning. If your account size does not qualify you to see a top investment advisor (often a minimum of $250,000), you can’t go wrong with a fee-only planner. The fabulous MoneySense magazine maintains a directory at http://bit.ly/1I1Ko8u.

BECOME A DIY INVESTOR 

Last, but certainly not least, you could learn to invest on your own. Without a bank or an advisor. The basics of investing are not complicated and taking the time to understand them can add over half a million dollars to your retirement. Would $500,000 make a difference to your future? While I absolutely support working with a great advisor, I also believe that every Canadian should understand the basics of investing and the true cost of investing fees. If you would like to get started, you won’t go wrong with my free 30-day training, Investing Bootcamp.

Click here, or fill out the below form to sign up anytime.

 

That’s it for today! Any questions, feel free to visit Ask Nanci.

Ask Nanci: How much do I pay my financial advisor?

how much does financial advisor make

I received the following question (via Ask Nanci) from Debbie in Saskatoon:

Can you help me understand how my financial advisor gets paid?  I don’t see fees on my account statements and I’m shy to ask.

Thanks for your [awesome] question, Debbie!  You are certainly not the first person in Canada to look for this answer.

FIRST:  Financial Advisors need to get paid. Especially if they are good, because a good FA can change your whole life—for the better. That said, every person who uses the services of a broker or advisor deserves to know what they are paying for said products and services. And unfortunately, this is not always the case in Canada.  

It has been over a decade since I worked in the industry and I’m not going to comment on how any one individual, in any industry, chooses to charge for their services. But I will share with you a basic model of how most financial advisors are paid in Canada, and you can decide if that model works for you. 

A very rough marker in North America is to pay 1% for advisory fees.  

What does this mean to you? 

An ideal situation is to pay a 1% fee on your total assets.  It is not super realistic to pay 1% on cash balances (it’s not exactly high maintenance, cash…) and so the breakdown often looks something like this: 

Equities: 1.25%
Fixed income: 0.75%
Cash: 0.25%

Therefore, a $500,000 portfolio of 55% equities, 40% bonds, and 5% cash would have management fees of $5,000 (or 1%, right?)

$275,000 x 1.25% = $3,427.50
$200,000 x .75% = $1,500
$25,000 x .25% = $62.50

And—this is important—the 1% you are paying for advisory, would include a foundational level of service for insurance, estate and tax planning—or at least to play nice with your Accountant and other advisors. Also, if you are using ETFs or low-fee mutual funds for diversification, you can expect to pay roughly 0.2% on those assets as well. Meaning your total fees for the year could be between 1% and 1.25%. Again, this is just an average.

Ok, you knew it was coming—math. 

(the title was supposed to read “Very, Very, Very Important Financial Advisor Math”, but it wouldn’t fit on the slide… Click on the image to make in bigger!)  

financial advisor salaries

Stay with me on this one.  

Assumptions on this slide: 

  • Advisor is charging 1% per year
  • Advisor has to share 50% of her revenue with her employer
  • Advisor can realistically see no more than 300 clients per year 

And what this means is that if an advisor plans to earn $112,500/year, she cannot realistically accept any clients without a minimum balance of $75,000.  And if that same advisor intends to earn $247,500/year, she cannot afford to take on a client without a minimum account balance of $165,000. 

The reality of the situation, is that many of the best financial advisors in Canada have a minimum balance requirement of $250,000.  Which, in turn, means that most of us simply cannot afford (yet!) the services of a top-level financial advisor.  

The Mutual Fund Industry 

Debbie did not share with me her account balance, but I am going to assume that she is not seeing a high level financial advisor. Why? Because their fees are transparent, and you pay them outside of your account. Why? So that you do not lose the compounding benefit of these fees year after year, and so that you have a receipt because investment advisory fees are tax deductible. 

Because Debbie is not 100% clear on what her annual fees are, my best guess is that she is holding mutual funds, through either her bank or a mutual fund company (i.e. AGF, Fidelity, McKenzie).  Without knowing the specifics of Debbie’s account, I can tell her (and you) that the average MER (annual management expense ratio/fee) is 2.5%.  If that seems high to you, especially in comparison to the 1% charged by top financial advisors, you are right—they are high. 

In fact, not only does Canada have the highest MER’s in the world, but Morningstar recently (2011) gave Canada a failing grade for it’s high fees, the highest of 16 countries.  It was the only country on the list to receive an F. 

What would my advice be to Debbie?  

If she is shy to speak with her advisor, she can simply look at her statements and Google the names of the mutual funds she is holding. Adding “MER” after the mutual fund name, will bring her to several websites (Morningstar, Fund company, GlobeInvestor) where she can locate the MER for each of her funds. At this point she can decide if the fees she is paying are worth the services she is receiving.  

And if Debbie is not happy with the fees she is paying for mutual funds or investment advice, she can click here to read my post, Just Found Out How Much You Are Paying In Mutual Fund Fees

Whew! That was a long one—thanks for sticking with me to the end. 

If you have any questions, don’t hesitate to send me a note through Ask Nanci.

 

A Few Words On DSC Funds

mutual fund fees canada

Anyone that has ever worked with me, knows that I am not a fan of mutual funds—especially in Canada. There are several reasons, the top three being:

  • Active management almost never beats passively managed lower-cost index funds 
  • The MERs (management expense ratios) on mutual funds (especially in Canada) are ridiculously high 
  • Inflated sales commissions and/or high trailer fees can influence recommendations made by Advisors 

First, let’s be clear. Financial Advisors need to get paid. Especially if they are good. The issue, for many years, has been there is a lack of transparency on how they are paid, and because of this lack of disclosure, some clients assume that their Advisor is paid by the mutual fund company, and not by themselves. This could not be further from the truth.

If it’s not clear: everybody gets paid, and you pay everybody. 

Here’s how: 

There are three primary way to  pay your financial advisor or broker for a mutual fund purchase: 

1) Front end load:  A fee of (often) 5% – 6%, rarely as high as 9%. This can be negotiated.   

2) No-load:  There is no fee to buy or sell the mutual fund (it is possible that the funds MER can be higher for this option) 

3) Back-end load (also known as: deferred sales charge, or DSC). There is no charge to purchase the fund, however there is a significant (yet, declining) fee to sell or redeem the fund.  Having worked in the industry, I can tell you that some Advisors love, absolutely love, to use DSC options.  This is why: 

Because there is no fee to purchase the fund, and the actual details of the fee structure are buried on page 123-4.b of a long, boring document, clients assume their mutual fund purchase is free.  Which it technically, sort-of, may be, but only if you do not sell the mutual fund for seven years.  This detail is often left out of the conversation.  

But why do some Advisors love the DSC so much?  

Because it pays them an immediate 4% – 5% commission on your investment.  Without you knowing. (as opposed to the front-end load, which could be 5%, but then because you know about it, would have the chance to negotiate it). 

You know me. I love to walk you through these details. Let’s do this: 

You have $25,000 to invest.  Your mother is suggesting you see her Advisor at Investors Group, however, a colleague at work is telling you to open an account at Questrade and purchase Vanguard ETFs. 

We will start with an Investors Group option. The Investors Dividend A (Series A, DSC) has an MER of 2.39%, and the following redemption schedule: 

mutual funds Canada Investors Group DSC

Let’s assume you invested the entire $25,000 on January 1, 2015 in the fund.  

 …time passes. 

In February of 2017, you decide to return to school and get a masters degree and you need your savings for your a lump sum deposit at Harvard University. (OMG, you got into Harvard?! Congratulations!).  

Let’s say hypothetically that the fund returned:

  • 12.6% in 2015,
  • 9.6% in 2016 and
  • 3.5% YTD on February 28, 2017.

All amounts before fees.  (you know we are going to calculate compound interest and fees together now, right?!) 

January – December 2015

$25,000 x 12.6% = $3,150 (25,000 x .126 = 3150)
$25,000 + $3,150 = $28,150

On December 31, 2015 you have $28,150 and just before midnight, IG is going to take their 2.39% MER fee.  On the entire amount

$28,150 x 2.39% = $672.79 (28,150 x .0239 = 672.79) 
$28,150 (your original $25,000 + your $3,150 in 2015 gains) – $672.79 (fee to IG) = $27,477.21

Got it, sprocket? 

January – December 2016

$27,477.21 x 9.6% = $2,637.81 (27,477.21 x .096 = 2,637.81)
$27,477.21 + $2,637.81 = $30,115.02

On December 31, 2016 you have $30,115 and just before midnight (yep, you guessed it!) IG is going to take their 2.39% MER fee.  On the entire amount

$30,115.02 x 2.39% = $719.75 (30,115.02 x .0239 = 719.75)
$30,115.02 (your original Jan 1, 2016 capital $27,477.21 + your $2,637.81 in 2016 gains) – $719.75 (fee to IG) = $29,395.27

Still with me?!

January – February 2017

$29,395.27 x 3.5% = $1,028.83 (29,395.27 x .035 = 1,028.83)
$29,395.27 + $1,028.83 = $30,424.10

I am not sure if/when/how IG would charge their 2.39% MER on the first 60 days of the year, so for the sake of simplicity let’s leave it out.

February 28, 2017- Harvard! 

OK, so now it’s February 28, 2017 and you need your money, which is valued at $30,424.10.

If we look at the deferred schedule again (taken from this IG document, remember that long boring document I mentioned above, see page 18):

mutual funds Canada Investors Group DSC

…it’s going to be 5%, or: $1,521.21 in redemption fees, leaving you with $28,902.89 for Harvard.

I am curious, how you feel about this amount?

Let’s dig a little deeper into the numbers.

  • You started with $25,000 and are leaving with $28,902.89, a return of $3,902 on your initial investment in 26 months.
  • IG received total fees of $2,913.75.  What this means is that your $25,000 actually returned $6,815.75 but IG took $2,913.75 in fees, leaving you with $3,902.  Meaning, IG took 43% of your total returns.  

How do you feel about the numbers now? 

But we aren’t finished yet!  I am sure you need a break (God knows, I need a break..).  We ran an example of what could hypothetically happen if we visited your Mother’s Financial Advisor at Investors Group.  Now let’s see how things might turn out if we took your colleague’s advice and opened an account at Questrade. 

An almost identical ETF to the Investors Dividend A is the Vanguard FTSE Canadian High Dividend Yield Index, which trades on the Toronto Stock Exchange under the symbol VDY.  I would show you the redemption schedule for VDY, but there is no redemption schedule (or front-end load, no-load, or back-end load) on stocks or ETFs.  You pay a commission to buy a stock or an ETF and so the mutual fund industry loves to proclaim their products are “commission free”.  Certain discount brokers, including Questrade and Virtual Brokers, now allow you to purchase ETFs at zero commission.  This is fantastic, not just because you save the $7.00 (yes, it is like, $7.00) on the initial purchase, but should you (and you should!) invest a regular amount each and every month, these subsequent purchases would also be commission fee.  Meaning?  You could amass a small fortune without paying a single dollar in fees. 

At any rate, I’ve digressed (but just a little). 

Same story/returns as the Investors Dividend A fund in the example above: 

  • 12.6% in 2015,
  • 9.6% in 2016 and
  • 3.5% YTD on February 28, 2017

Again, all before fees. 

January – December 2015

$25,000 x 12.6% = $3,150 (25,000 x .126 = 3150)
$25,000 + $3,150 = $28,150

On December 31, 2015 you have $28,150 and just before midnight, Vanguard is going to take their fee of .3% (what’s that?  A typo?  A misplaced decimal?!  What is this 0.3% MER you speak of?!) Yes, yes!  That right there is everything I want you to know about investing in Canada!  …and, I’m back.  So that’s $84.45 to the good folks at Vanguard Canada. 

$28,150 x 0.3% = $84.45 (28,150 x .003 = 84.45) 
$28,150 (your original $25,000 + your $3,150 in 2015 gains) – $84.45 (fee to Vanguard) = $28,065.55

January – December 2016

$28,065.55 x 9.6% = $2,694.29 (28,065 x .096 = 2,694.29)
$28,065.55 + $2,694.29 = $30,759.84

On December 31, 2016 you have $30,759.84 and just before midnight (yep, you guessed it!) Vanguard is going to take their 0.3% MER fee on the entire amount. 

$30,759.84 x 0.3% = $92.27 (30,759.84 x .003 = 92.28)
$30,759.84 (your original Jan 1, 2016 capital $28,065.55 + your $2,694.29 in 2016 gains) – $92.28 (fee to Vanguard) = $30,667.56

Hang in there – we’re almost at the punchline! 

January – February 2017

$30,667.56  x 3.5% = $1,073.37 (30,667 x .035 = 1,073.37)
$30,667.56 + $1,073.37 = $31,740.93

I repeat, I am not sure if/when/how Vanguard would charge their 0.3% MER on the first 60 days of the year, so for the sake of simplicity we will again leave it out. 

February 28, 2017- Harvard! 

OK, so now it’s February 28, 2017 and you need your funds, which are $31,740.94

Assuming you will pay the highest average discount brokerage commission of $9.99 to sell all your shares of VDY, you will receive $31,730.94.

And so I leave the final decision with you. Visit your Mother’s Advisor at Investors Group (or almost any other mutual fund company in Canada), buy a DSC mutual fund and have $28,902.89 for Harvard, or open an account at Questrade (or almost any other discount broker in Canada), purchase shares of VDY-T, and have $31,730.94. 

Choose wisely. 

Disclaimer: I own a truck-load of VDY-T in my RRSP
Reminder: The above examples are for illustrative purposes only. I obviously cannot predict what the 2015, 2016, and 2017 returns will be for either Investors Dividend A or the Vanguard FTSE Canadian High Dividend Yield Index ETF. The published MERs are factual and were taken from publicly available sources on, you know, the Internet (so they must be true!) I do believe there is a high-correlation between the two funds, and that it would not be unrealistic for the fund and the ETF to produce very similar returns. I would tell you that you should check with a Financial Advisor before making any investment decision but even I recognize the irony in that statement after the above post I just published. However, since my blog is for educational purposes only, I will say perhaps you should consult a fee-only Financial Advisor (who does not sell DSC mutual funds). MoneySense magazine maintains a directory here.