How to improve quality of financial advice

March 9 2014 by Ellen Roseman

CBC Marketplace recently tested advice given by 10 banks and investment firms. Using hidden cameras, it showed what happened when a potential client walked into each firm and said she had a $50,000 inheritance to invest.

While some firms performed well, others gave advice that Marketplace’s expert Preet Banerjee described as atrocious. Here are highlights:

In some cases, information was incorrect or misleading — even in response to direct questions, such as how fees are calculated.

Some gave unrealistic promises about returns, including one adviser who said that a $50,000 investment should increase by $10,000, $15,000 or $20,000 in one year.

Others failed to adequately assess the customer’s risk profile, which advisers are supposed to use to ascertain the suitability of investment products they recommend to a person.

I have my own story to tell about Maddy (not her real name), who works at the Toronto Star and told me of her dilemma.

Nine years ago, she met a friend of a friend who sold mutual funds. At the adviser’s urging, she took out a $50,000 line of credit to invest.

She was losing sleep because she hadn’t repaid any of the $50,000 — and she hadn’t gained much ground with the mutual funds purchased on her behalf.

Maddy didn’t understand the strategy, but did trust the adviser. She only started questioning things when her adviser quit the firm.

She decided to pay off the line of credit. But this wasn’t easy to do.

The adviser had invested the money in a dividend mutual fund. Each distribution was used to buy more mutual funds inside her RRSP.

Maddy had to pay deferred sales charges (DSCs) on the dividend fund. While DSCs disappear after seven years and she held the fund for nine years, each distribution started the clock running again.

Since she couldn’t sell her RRSP funds without incurring a big tax bill, she decided to transfer the portfolio to another adviser.

As a result, she could repay the line of credit only by contributing more money. The DSCs reduced her initial capital and the modest growth didn’t offset them. Meanwhile, she spent thousands on interest over the years.

Borrowing to invest rarely makes sense, except for sophisticated investors who can hold securities for years without being tempted to sell. Maddy was inexperienced and agreed to a leverage strategy when pushed to do so by her adviser.

The Investment Industry Regulatory Organization of Canada recently put out an investor bulletin on borrowing to invest. I don’t think it goes far enough.

Here’s a comment by Lindsay Speed, legal counsel and corporate secretary of FAIR Canada, an investor advocacy group. (I’m chair of the board.)

In my view, the warning language should be stronger. We have been advocating for regulators to take the position that leverage is only suitable for the most sophisticated investors.

This seems to suggest that the suitability onus is on the investor, not the adviser. And there is no mention of why an adviser would be motivated to recommend leverage.

FAIR’s recent work on leverage is shown here and here. It believes borrowing to invest is promoted by advisers hoping to increase their assets and earn more commissions and trailer fees.

If you pay for advice separately from products, you get better recommendations. Look for a fee-based adviser if you want a plan suited to your needs.

Otherwise, you can become a victim of incentives that put the advisers’ interests ahead of your own.

2 comments

  1. Neil Murphy

    Mar 9 2014

    Great article. The interesting thing left unsaid is the real motivation behind the story.

    The financial advisor encouraged the ‘borrow to invest’ strategy to line their own pocket with the upfront commission attached to that DSC strategy.

    Regulation will not solve the problems of unsuitable recommendations in the investment industry.

    We must fix the systemic conflict of interest resulting from how advisors are paid — commissions on product sales, based upon the size of your assets.

    Remove the motivation that permits the bad behaviour and watch that behaviour fix itself.

    Neil

  2. Lorne Marr

    Apr 2 2014

    Neil, I’m not sure the fix is as easy as to remove commissions from product sales.

    Commissions or bonuses are inevitably tied to sales. Even salaried sales employees are almost always paid bonuses, which is essentially commission.

    I think the key is for consumers to have clear and understandable disclosure of the risks and fees involved.

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