We've all probably met a financial advisor who told us to buy a "balanced mutual fund," and hard sold their own company's "top performing" fund. They tell a good story, but do they really have our best interests at heart?
Chances are, many of our parents have had this experience too and now have a bunch of mutual funds in their portfolio because they kept buying the "HOT fund." It's like an impulse buy -- you come home wide-eyed, enthusiastic, use it a few times, stick it in a closet, and let it collect dust for years.
Unfortunately, they probably have no idea how the funds are actually doing or how much they are paying in fees. In fact, they might not remember the reason they invested in the specific mutual funds in the first place and will rationalize it with phrases like "it made sense at the time."
Each mutual fund was purchased in hopes of reaching a goal -- a bigger house, your college education, or a safari vacation -- but that goal was probably never reached. Despite this, they are still holding on to their funds.
Here are five compelling facts to help you convince your parents (or yourself...) to get out of mutual funds and finally see the Serengeti plains while they are still young:
According to a study, the average total cost of investing in a Canadian mutual fund is 2.2 per cent, representing some of the highest fees in the world. As savings grow, these fees become significant; someone with a $500,000 portfolio will pay $11,000 per year in fees. Sometimes it's even more, with the average balanced fund fee being 2.63 per cent. These fees remain the same regardless of account size. Most Canadians aren't clearly informed of these fees and rarely ask themselves if they are getting that much value out of their financial advisor or their funds.
The "Gifted" Program
Most people believe that they are above average, and money managers are no different. In fact, according to a McGraw Hill Financial study for the year ending in 2014 in Canada, 70 per cent or more of managed funds underperformed compared to the S&P/TSX Composite over the last five years. Statistically speaking, the higher the fee the worse the performance -- question the idea that the more it costs, the better the result. It's in fact the opposite.
Limited Exposure to Other Markets
There are phases in markets when the returns are abysmal -- this is part of a normal market cycle and is expected. During those times there are opportunities to be found outside stock markets and bonds to make money. Most of these opportunities are closed and very hard to find to the average investor.
Most mutual funds only invest in publicly listed stocks or bonds -- "balanced" mutual funds aren't really that diverse. They are generally heavily weighted towards Canadian stocks and bonds, and when both are down, portfolios struggle. Such limited diversity then excludes opportunities in private equity, real estate, commercial mortgages and other investments which can generate a steady cash flow even when times are tough. It also increases opportunities for a portfolio manger to purchase undervalued assets because they have more tools to work with.
Diversifying beyond the typical mutual fund made of stocks and bonds is always a sound, long-term strategy. Not only does it limit your exposure by having your eggs in different baskets, but it allows you to seize a more diverse range of opportunities when those markets are performing poorly.
Lack of Transparency and Reporting
Ever read a report from a financial manager? Were you able to easily find the performance and the cost? Probably not. When the info is there, it's presented in a way that makes it confusing, inundated with acronyms and terminology. In fact, mutual fund transparency has been so historically abysmal in Canada, the government has finally stepped in to implement new requirements around reporting. It's too bad that it takes government intervention to simply show investors how they're doing and what they're paying, without any spin or fine print. It doesn't have to be this way.
Look for clean and clear reporting on fees and performance, and avoid advisors that sell products on commission. It will remove any doubt about conflicts of interest and clear up questions about the true value you are getting.
No Financial Plan in Place
Unfortunately, many clients don't receive any comprehensive planning with their investments. Others often get one that is built from a recycled old template. So what are you paying your planner for?
The reality is that many financial advisors are focused on sales, or are too inexperienced to actually produce an effective plan. This can lead to not investing your money where you need to achieve your goals, but instead in a product that will help the advisor meet theirs. Often times that's an investment that pays the highest commission or is the easiest to sell.
In order to efficiently have your wealth grow, clients need a comprehensive plan based on their goals, time horizon, risk tolerance and unique situations. Simply getting the right advice when choosing between a TFSA or RRSP contribution can save thousands in taxes.
Having a well thought out financial plan in place from an expert that has your best interests in mind will go a long way in helping you reach your financial goals.
How To Fix It?
The fact of the matter is that no one can predict the future. Even the best analysts and fund managers make mistakes. Diversification and long-term planning work much better than market timing. Over time, this strategy reduces the downside exposure on our investments.
Because of this, broadly diversified long-term investment portfolios are one of the best wealth management strategies - and one that requires discipline and planning. The first step is to create a plan, the second is to stick with it.
Knowing these facts, we should ask: How can we help our parents find better investments? Find an advisor at with transparent tools, planning and reporting. Access to low-fee, diversified ETFs will save your parents thousands, meaning they can finally book the safari they always wanted.
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