Just Say No

Kelly Rodgers, MoneySense April/May 2003

As if the bear market weren't bad enough, you may now have to contend with financial advisers who are desperate to sell you new products. You can blame this army of money-hungry advisers on the revenue collapse at many financial service firms. These firms have seen their profits crushed as investors reduce their purchases of mutual funds and stocks. As a result, they're pressuring the advisers they employ to either generate more revenue from clients or look for another career.

Prime target for those desperate folks is you. Here are a few sales pitches you may be hearing from your adviser.

Let's switch you to a fee-only or money-management account. Financial advisers have traditionally earned a hefty commission on the products they sell you. The problem is that this system creates an incentive for advisers to churn your account with needless trades so they can generate extra commissions. Fee-only and money-management accounts attempt to remedy this problem. These accounts charge no commission on your transactions; instead, you pay a flat annual fee for the privilege of having an adviser oversee your money.

In theory this can work to your advantage, but in practice everything depends on how large a fee you're being charged. Before agreeing to anything, perform a quick fee comparison. If the proposed annual fee is less than you've been paying in annual transaction costs over the past three to five years, the new account structure could be worth your while. But if the annual fee is higher than the average of what you've been paying, reject the proposal or suggest a lower annual fee. Your annual fee should not be more than 1.75%, including any fees charged to the products in your account.

Have I got an income trust for you. Income trusts operate like standard companies, but unlike corporations they're bound by law to pay out most of their earnings to investors in the form of regular income distributions. The yields they pay to investors average about 10%.

White the yields can be tempting, make sure you understand a trust's fundamental business before buying its units. Although many income trusts are sound investments, some are not. If earnings fall, your distributions can be cut and the value of your units can fall. On the Standard and Poor's Web site (www2.standardandpoors.com), you can find ratings for a variety of income trusts.

Be especially cautious if your adviser is trying to strong-arm you into a trust that has just been launched. He or she could be receiving a financial reward on the order of 4% to 5% of your investment. That's quite a lot when you consider that you can buy trust units that are already trading on the Toronto Stock Exchange for a commission of just 1% to 3%.

Let's redeem some of your underperforming mutual funds and put the proceeds into a new fund. As I've noted above, most advisers make their money from the commissions they generate on selling you products. Their favorite way to do that is to encourage you to buy new funds. In fact, some advisers these days are even offering to sweeten the deal by offering to reimburse you for any redemption fees on your old funds. Just make sure you understand what's going on. Your adviser will likely receive a 5% commission on the new fund. So even it your adviser pays your 2% redemption charge on your old funds, he or she is still ahead by 3%. You can get around this problem by simply refusing to buy any more backend load funds.

If you want a cheaper alternative, go with a good balanced fund. A balanced fund, which invests in stocks and bonds, is in many cases the only mutual fund that investors need. A good one will give you strong returns, with only moderate risk. And it removes the need for a financial adviser since the fund itself takes care of most asset allocation decisions.

Good balanced funds should have management expense ratios (MER) below 2%. I especially like the Canadian balanced funds from four firms: Bissett, Mawer, McLean Budden and Phillips, Hager & North. They are all good, low-cost funds that should deliver fine results in the long term.