Five key steps to evaluate and monitor this important relationship
In Canada, advisers are required to act with “honesty and good faith.” Canadians expect their advisers to act in their best interests, although the definition of best interests is difficult to define for many people.
Many people are not aware of how their adviser is performing. Are you aware of your investment performance- and your investment costs? How do you evaluate the service that you receive?
The investment industry is complex, with thousands of options. Costs can be high and/or hidden, and it is very rare to find an account statement that tells you what you made investing. Even if you do know your total return, how can this information help you evaluate your adviser?
This article suggests five simple steps to help investors make sure their money is being managed properly:
1. Understand your total return over time.
To assess the value of your adviser’s services, you need to understand what you made while investing with them. This is called your total return. It includes capital gains plus all interest and dividends. It does not factor in your investment costs or any taxes you may pay.
In most cases, you won’t find your total return anywhere in your account statements. But most advisers should be able to get this information for you, going back to the beginning of your relationship with their firm. In fact, there is a growing movement to get the investment industry to make it mandatory for advisers to provide this information to their clients on a regular basis. For now however, you’ll need to make sure that you get this information yourself.
Of course, short-term returns are less meaningful than long-term. So, try to find out your total return for the longest period that you can. Measuring average returns over at least 5 years will give you the best idea of how well your advisor is looking after your assets, but even 2 or 3 years of data can be useful.
Tip: You can calculate your total return yourself at www.showmethereturn.com.
2. Calculate your total costs for each year.
When you shop in a supermarket, you know exactly what it costs. When you invest in the stock market, you are often left to guess. Yet your costs reduce what you make investing, so it’s important to have an accurate picture to assess whether your investment choices are working out the way you hoped. .
Make sure that you get a full accounting of all costs including:
- Sales fees and commissions (mutual fund and stock trading)
- Fund management expenses (MER)
- Administrative charges (such as RRSP fees)
- Any asset-based fees (some advisers may offer you their services with no commissions. Instead, they charge a yearly fee which can range from 0.5-2.0% of the assets in your portfolio).
Low costs and better returns often go hand in hand. For example, let’s say you own two funds that both make the same return before costs in 2007: an index fund charging only .55 percent a year and a traditional mutual fund that charges 2.50 percent yearly. Although this difference of about 2% may seem minor, it is not. In this case, the index fund would reduce your fees by over 75%. On a $10,000 investment, you would save almost $200 in fees alone in a single year.
To put it another way, if both products returned 8%, you would keep 7.45% of your growth with the index fund and only 5.5% of the growth with your mutual fund. The mutual fund would have to significantly outperform the the market index just to recoup the extra fees that you are paying- and statistics show that mutual funds as a group aren’t able to consistently do this. Over time, this will make a substantial difference in the value of your portfolio.
Learn more about investment costs
On the other hand, the cost of an investment doesn’t always tell the whole story. The DMP Canadian Value Class fund charged a very high 4.11 percent MER, but still returned more than 28 percent in 2006, even after you deduct those costs. That’s nearly twice what you would have made investing in an average Canadian equity fund or the TSX that year. There are exceptions to the rule- but they can be very rare.
How do you get information about your total investment costs? Just as we saw with total returns, you won’t likely find it in one place on your statement. Even if you have a wrap or asset-based account, where you are charged specific dollar amounts, you may still need to add up your yearly total. You can either:
- Do the homework yourself. Go through all your account statements and transaction records for the past year and assemble the best picture you can of what it cost you to invest.
- Or, ask your adviser to calculate what you pay each year as a percentage of your portfolio.
Remember: The point of having an adviser is to achieve adequate long-term returns that fit your goals. That’s why you need to be aware of the cost of the advice that you are getting.
Oh Canada: why are mutual funds so costly? A recent Harvard Business School study on mutual fund fees around the world found Canada’s costs are the highest by a large stretch. The study, “Mutual Fund Fees around the World”, compared mutual fund fees in 20 countries – including Europe, Japan, Australia, the US and Canada. We pay 67% more than investors in the US for equity funds; and 263% more than the frugal Dutch. And that’s just for the usual mutual fund management costs.
3. Compare your results to appropriate benchmarks.
Your total return, minus your total costs, shows how well you’ve done investing. The next step is to compare your results to how the markets did, using an accepted benchmark. What’s a benchmark? Simply put, it is the market return over time for a certain mix of investments and the types of investments used in the benchmark tend to remain consistent over time. If you use one with similar type of content (eg bonds, stocks, small cap, resource, etc.) and risk as your portfolio, it can provide a reasonable yardstick to compare with the performance of your investments.
The S&P/TSX Composite index is one example of a benchmark. It tracks certain large Canadian companies that trade on the Toronto Stock Exchange. Other indexes track stocks in different industries or countries. Still others track bonds or commodities like gold, silver and oil.
The key is to identify the right benchmarks to use to assess your portfolio. Then you can see how well or poorly you have done compared to a similar mix of products with similar risks.
You will likely need to use a mix of indexes to mirror your investments. For instance, if 25% of your investments are in Canadian bonds, then you need to use a bond index or benchmark for this part of your portfolio. Your adviser can help you understand the specific benchmarks that most closely match your portfolio.
Important: Benchmark results do not factor in investment costs. That’s why most investors using a full service adviser will have lower returns than a benchmark. But even after costs, your returns should at least come close to the benchmark. The pattern of change each year should also be similar. In other words, if the benchmark is up, your results should be up, too.
Of course, if you are paying for an adviser’s help, you likely want to see better results than the market as a whole. But only you can decide if you are getting enough value from your advisor relationship to justify the cost. It’s vital to consider the total value your adviser provides (see Step 4).
Did you know? Mutual funds and wrap accounts are compared to benchmark indexes that contain a similar mix of investments. For example, Canadian Equity funds are compared to the S&P/TSX 60 Total Return Index; US Equity funds are usually compared to the S&P 500 Total Return Index. For fixed income, the most common benchmark is the Scotia Capital Universe Bond Total Return Index. You can find the returns for these benchmarks in the fund profile pages at www.globefund.com or at www.tsx.com under “Indices and Constituents”.
4. Assess the total value that your adviser provides.
Once you have compared your results to the appropriate benchmarks, you can get a better idea of the value you are getting from your adviser. A recent study from the Harvard Business School shows that adviser value cannot be taken for granted. The study, “Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry,” found that investors using advisers to help them choose mutual funds had returns that averaged less than half those of investors working on their own. That’s why it is critical to know your returns and costs in order to assess the value of the services that your adviser provides.
Of course, this is not to say that the average investor would always do better without an adviser. After all, there are many benefits to outsourcing these decisions to the professionals. That’s why the numbers don’t always tell the whole story about the value your adviser offers. To assess the total value you receive, consider some of the other advantages, such as:
Helping you map out your investment strategy based on your financial goals, tolerance for risk and time to invest
- Giving you access to research and information you may not easily find on your own
- Saving you time by analyzing suitable investments
- Keeping you up to date on economic and business news.
- Monitoring and balancing your investment portfolio regularly, when needed
- Helping you avoid common investing mistakes including emotional decisions as markets go up and down
- Keeping track of necessary paperwork and documents.
Only you can decide if these elements provide enough value to justify the price you pay for the advice you get. It depends to a large extent on your knowledge and experience as an investor – and how confident you are that you could do better with a different adviser, or even on your own.
Related contentLearn more about what to expect from your adviser
5. If you are not happy with your results over time, talk to your adviser.
If your returns are disappointing year after year, address your concerns with your adviser directly. Ask if there are ways to reduce your costs or change your investment strategy to improve your results. The conversation should be about your portfolio and improvements your adviser can make now. Don’t wait for good markets in the future to solve existing and ongoing problems. If your adviser seems unwilling to help, you do have some other options. You can even consider changing your adviser. For example, you could move to:
- A discretionary fund manager, who often demands high opening balances but lower trading costs
- A discount brokerage, which offers very competitive trading costs but little or no advice. This option demands a serious investment of time and interest and is better for people with a passion for investing and a deep skill level.
Watch this video of Dan Richards, president of Strategic Imperatives and a faculty member at the Rotman School of Business at the University of Toronto, with Rob Carrick from the Globe and Mail discuss how to work with an Investment Adviser to learn more.
Important: Switching advisers is a serious decision. Watch out for transfer fees of roughly $125/account (although these can be waived). There may also be big costs and tax consequences if your new adviser recommends changes to your portfolio. Advisers like to have clients in similar products, anticipating similar market conditions. It makes managing large numbers of clients much easier. Make sure you discuss any potential changes to your portfolio with the new adviser before you decide to switch.
Remember: you – not your adviser – are ultimately responsible for how your money managed.
Even though it is easier than ever to invest on your own, many advisors can and do offer good value. The key is to be better informed so you can be a more astute consumer.
After all, it is your money. You worked hard for it – and once lost, it is difficult if not impossible to replace. So don’t hand your assets over to a stranger and tell them to do what they think is best. You need to assess you adviser regularly. Ask the hard questions. And, if necessary, be ruthless. A simple change in strategy or cost structure may make a big difference in your long-term returns.
Your goal should be to get fair value from your adviser for the costs you are paying. Later in life it can mean the difference between retirement comfort and anxiety.
Watch this video of Warren MacKenzie, president and CEO of Weigh House Investor Services, with Rob Carrick from the Globe and Mail discussing getting a second opinion on your investment portfolio.
Notes and references
Note 1: figures from Globe Interactive mutual fund database as of Dec. 31, 2006
Note 2: research from Dalbar Inc. Quantitative Analysis of Investor Behaviour Study. 2003; and from The Little Book of Common Sense Investing, by John Bogle, 2007, p. 56.
Bergstresser, D., J. Chalmers, and P. Tufano. Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry. Harvard Business School, 2004
Dalbar Inc. 2003 Quantitative Analysis of Investor Behaviour Study. 2003
Moine, D. The Study of the Decade. Morningstar, 2006
Khorana, A., H. Servaes, and P. Tufano. Mutual Fund Fees around the World. Harvard Business School, 2006
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.