What your adviser doesn't have to tell you

Kelly Rodgers, MoneySense October 2000

Most of us believe that our financial advisers are obligated to act in our best interests, giving us the best advice they are capable of delivering. Reality, however, is radically different.

Consider this amazing fact: most financial advisers are not obligated to recommend the best mutual fund for your portfolio. They don't even have to recommend a good fund. All they have to do is ensure that their advice doesn't clash with your investment objectives. That could mean recommending a lackluster mutual fund simply because it puts more money into their own pockets.

That might look like a conflict of interest, but it's perfectly acceptable. The relationship that exists between you and your financial adviser is known as an agency duty of care, which means that he or she must recommend products and services that are appropriate for you. But it doesn't mean that these products have to be the best, or the cheapest.

Want an example? Bankers have an agency duty of care to clients, so when you renew your mortgage, they must tell you truthfully what the posted rate is. But they don't have to tell you that you can get a lower rate just by asking.

There's nothing wrong with an agency duty of care, but misunderstanding the nature of the relationship can create a dangerous situation for investors who follow their financial advisers' recommendations to the letter. Advisers are supposed to be experts and you want to believe that they will act in your best interests. Unfortunately, many people end up with accounts full of overpriced and underperforming investments as a result of misplaced trust in their advisers.

Let's take a look at C.I. Harbour Segregated, GWL Growth Equity (A) and MLI C.I. Harbour GIF. These three mutual funds are extremely expensive, costing investors over 3% of their investment money every year. Such skyhigh fees could only be justified if the funds had stellar track records.

In fact, all three funds rank in the bottom of their peer group, according to performance rankings in The Globe and Mail. And - here's the kicker - each fund is thriving, with more than $35 million in assets. It shows that many advisers are probably recommending these funds, not because of great performance but because they reward advisers well.

If you depend on your adviser for recommendations and don't feel comfortable standing up to him or her, then you should definitely consider establishing a different type of relationship, one known as a fiduciary duty of care. This means your adviser must put your interests ahead of his own, and must ensure that there is no conflict of interest.

However, getting your financial adviser to agree - in writing - to a fiduciary duty of care can be tricky. The majority of advisers won't do it because they stand to earn less money from commissions. Others might refuse because of the responsibility this relationship places on them. If they do refuse, then at least you know that you have a "buyer-beware" relationship and can act accordingly.

There is another option open to you, but only if you have more than $500,000 to invest. You can place your investments directly with an investment adviser who will manage your entire portfolio on a "discretionary" basis. This means the adviser does not need your consent before making an investment decision and, therefore, he or she is automatically assumed to have a fiduciary duty to you.

Not at the $500,000 level yet? You can open a "balanced wrap account" with an investment firm. In these accounts, all the fees and commissions associated with your investments are consolidated - or "wrapped' - into a single charge. Unfortunately, investment firms charge ridiculous prices for wrap accounts - as much as 3% of your assets annually. This makes it very difficult for these accounts to outperform the market and justify the price. However, with a balanced wrap account you do receive a fiduciary duty of care.

My advice is simpler and much, much cheaper. When your adviser recommends an investment to you, ask why he or she is recommending it. Also, ask if it's the best and cheapest product available, or if there is anything better. And get it all in writing, with signatures, just in case something goes wrong. Remember: nine times out of 10, you are entering into a buyer-beware relationship with an adviser, which is not that different from what you might expect with a used-car salesman.