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Choosing the Right Investment Advisor

I was catching up with a pharmacist friend in Yaletown this week when he told me that another buddy from back in the day had become an investment advisor (“IA”) and was coming over to talk about his finances.

We were grabbing dinner at Blue Water Cafe later that night so instead of going to the local dog park to kidnap cute dogs I acquiesced to buddy’s request to sit in during their chat.

Ultimately, I left that day after excoriating old and likely no-longer-buddy and am still quite raw from the experience. I felt compelled to write this for everyone who is going to see an investment advisor at CIBC Wood Gundy or RBC Dominion Securities – and especially for anyone who is speaking with an independent contractor working for the Sun Life Financial or Freedom 55.

Young Professionals Can Consider an Investment Advisor (Or Just Buy an ETF)

Before explaining what you should be looking out for, let us be clear – there are merits to having an investment advisor manage your money. Also, I have contemplated becoming an investment advisor because of my premier marketability and natural sales skills. In fact, I may actually be an investment advisor right now – but you would never know (I live in the North Shore, come find me).

1. Investment advisors have a large suite of good products that can generate above market returns net of fees – this is instrumental in growing your wealth assuming you cannot consistently beat the market yourself (and if you are reading this site, spoiler – you can’t).

We write extensively how we do like active management compared to indexing, but admit that indexing is far easier while still an excellent choice for 90% of investors. You can find someone who can consistently beat the market, but finding this someone can be as difficult as beating the market yourself. To find this person, you have to be prepared to ask tough questions.

2. The management fee that goes to the investment advisor is tax deductible, which means that an actively managed portfolio is relatively cheap (appreciating that aggregate management fees in Canada are still steep relative to the rest of the world)

3. Investment advisors at large banks have a full suite of other services including tax and estate planning that come for “free” (you are compensating them indirectly with a % of your assets under their stewardship) – this can be effective for minimizing capital gains tax and finding ways to reduce taxable income legally

4. You get to feel important because you have a “money guy” (or gal) – sometimes you will be roped into the private banking product as well where you get a Black Card

So investment advisors can certainly be good if 1) their incentives are aligned with yours; and 2) they know what they are doing.

This means that investment advisors will help you pick funds that have good reputations in the market for outperforming benchmarks (Fidelity, Mawer, PIMCO) and charge a flat, percentage fee every year that is included in the MER. No deferred services charges or front loads. They should also endeavor to help you minimize these fees.

And even if your investment advisor is not good, you can still do well if you know what you are doing – by telling them exactly what they have to do and not giving them leeway to deviate from your instructions.

Here are some key things to know:

Never Be Afraid to Ask Tough Questions

If you are a Grade 2 in Piano, you can teach a Grade 1. Unless someone better than you is in the room, your student is none the wiser.

Many people are intimidated with investment advisors (and even mutual fund salesmen at their local TD Bank) because there is a perceived gap in knowledge. With the shiny offices, the bespoke suit and secretary dressed to the nines and the plethora of designations plastered on the walls and on the business card, most people lose before the conversation even begins.

Do not ever think this way. People feel social and commercial pressure when dealing with their advisors. Regardless of how smart they may be, they need to be able to answer your questions to your utmost satisfaction. Why? Because you are paying them a lot of money. As a rule of thumb, expect a 2% fee on your investments. 1% goes to Fidelity and 1% goes to the bank the investment advisor works for. The bank takes half and the investment advisor takes half – not the exact split, but close enough.

If you have $100,000 with them, you are paying $2,000 a year with $500 directly in the advisor’s pocket. If you have $250,000 with them, you are paying $5,000. If you have a million dollars between your wife with them and are saving for your child’s college education, you are paying them $10,000, as well as any hidden fees they may not tell you about. You deserve to know exactly what you want to know – and if you do not perceive their services as being worth $10,000, you should fire them. It is your money and $10,000 is not something that people throw away flippantly – if you hesitate to spend $10,000 on a watch or a handbag, you should hesitate to spend $10,000 on an advisor without them having your full confidence.

Investment Advisors Are Idiots

Second, their designations are meaningless. Ok, that is a little harsh, but none of the things they put on their wall make them at all qualified to be picking stocks for you – nor does it qualify them to pick the right manager to pick the stocks for you.

There is a very low correlation between how much an investment advisor makes and how good they are at making money for their clients. Sometimes, this is even an inverse relationship. I have had more than a few run ins with packs of investment advisors at IA conferences in Toronto getting very drunk at Brassaie and sharing with me 1) how much money they make ($5 million a year for a $1 billion book) and 2) how little they actually know about the markets.

Call me an elitist, but if I am getting any investment advice I like to see the following characteristics for the investment advisor – a CFA and/or previous work experience in capital markets or asset management at a top-tier organization (and I prefer asset management, because most investment bankers are terrible and extremely speculative investors). This means a shop like Fidelity, not a no-name brand. Not to sewer a bunch of designations, but the intellectual rigour required to get a CFP (which is sort of a gold standard with investment advisors for whatever reason) is immaterial compared to acquiring a CFA. PFP, CSC certified – if it is not a CFA pay no heed. Any advisor who puts down B.Comm or B.A. on their business card is an absolute schmuck.

It is actually disgusting that random idiots with a psychology degree from SFU decide that they can purchase a suit from Men’s Wearhouse and reinvent themselves as a finance guy. If the difference between you and the person managing your money is a crappy suit, you should reevaluate why you are paying them. Managing peoples’ money is a serious job and infractions happen most frequently when you have unqualified people rushing in to make a quick buck, harming the reputation of the industry on the whole.

The CFA in itself is also not a particularly challenging designation – it is just that the quantum of information that must be consumed in a short period of time is formidable. Accordingly, if a potential investment advisor has a CFA, you can at least be reasonably sure that they are not a complete moron and have at least spent hundreds of hours swimming in financial theory.

There are still plenty of awful advisors with CFAs, but if you are determined to work with an IA and are narrowing down the list of candidates, this can be a good start. A CFA does not guarantee success, but you have weeded out the people who cannot calculate market capitalization.

In the end, the only thing that matters is that you can find an IA that can get you in funds that consistently beat the market, preserve capital during downturns and stop you from making silly decisions. Now this is really hard to do, but we will try our best here.

Never Let an Investment Advisor Pick Stocks

When you meet with investment advisors, a lot of them tell you that they pick stocks for you. They do a pretty good job and show you the returns.

For most of them, that is pretty much as far as they want the conversation to go before you sign the bottom line and let them steward your life savings. Stay away from these IAs – they are not worth your time or money.

They will wilt when you ask them the standard questions – do you beat your benchmark? Would I be better off if I invested in the S&P?

Practically all of these guys just get the exact same crap as the index and charge you 2% on it – they rarely beat it, and if they do they certainly do not on a regular basis because they just have slightly different exposures. If you look at their top holdings you will see Royal Bank, TD Bank, Fortis – great, I could just buy the biggest companies in Canada and not pay you $10,000 a year.

The biggest thing to remember is that they are sales guys and they are not paid on how well they do relative to the market – they are paid on how big their book is (in terms of assets under management). So if you are a rich IA, you are not rich because you generated alpha. Managing investments is a full time job – how can an IA with 30 clients (where they are supposed to pick an individualized portfolio for each one) compete with a guy from Fidelity who has done it his whole professional life – starting from a lowly analyst and turning into a Portfolio Manager over 10 years. The answer is obvious – you can’t! Especially not if you are spending all of your time wining and dining clients.

They love to pull out a card – “we have an excellent group of analysts that pick the right stocks for us.”

And basically these analysts just pick the top conviction stocks from the bank’s equity research division (which is meant to generate demand and interest in equities – it’s complicated) and parrot the views of the analyst. Know this now – the function of equity research is not to help clients pick stocks that will outperform the market – it is to create awareness and offer views of a stock to keep it trading at an acceptable volume (liquidity).

If you ask your investment advisor about the individual stocks in the portfolio, they have one or two talking points that they’ve read off the page.

Ask them a tougher question – what does capex look like in the next two years? What are some risks associated with the stock? What has management’s track record been? What leverage do they have and what is standard for the industry?

At best, it will be “I’ll get back to you” because they do not know anything. They will not go into the detail required to be an able investor.

Also, here’s a secret from an ex-investment banker. Equity research guys build terrible models and are certainly not the brightest or best paid guys in capital markets (and I know our equity research page says they model better than investment bankers – the article was written by someone in equity research) and are consistently wrong. There are no repercussions for being wrong – you just lower your price target and explain it away because hindsight is 20/20.

If either the equity research guy or your investment advisor were that good at picking stocks they would make far more money in a hedge fund. So there you go.

Aside from all of this, whenever you entrust someone to pick stocks for you, you are paying all of those trading fees that add up where there may be conflicting interests. Sometimes, they may be incentivized to trade all day and collect commissions while destroying your wealth – I would certainly hope most advisors do not do this, but why take the risk. Who is the referee on whether or not that was a necessary trade? Are you going to be in the position to know?

Also, never let the investment advisor pitch you any funds run by the institution they work for. So if your advisor is from Manulife, never put allow them to talk you into a Manulife fund or a fund run by a Manulife subsidiary (everything they recommend, google who the owner is). Tell them that you do not appreciate this.

Obviously, if the fund is sold in house instead of using an external advisor such as Fidelity, the bank gets to keep the whole fee which means a bigger commission for the advisor. And these funds almost always suck and fail to offer any value.

Can Any Investment Advisor Beat the Market?

There are some very intelligent investment advisors who do beat the market picking stocks while fully serving their client responsibilities. They do not usually have sales obligations that are as large because these IAs tend to deal with an established high net worth clientele and possibly do not take on new clients or have to entertain them very often. However, they are rare and getting rarer.

I have met over a hundred investment advisors during my rather short life to date and can tell you that only two of them actually had any idea about what was going on in the markets. One was at an independent brokerage (think Raymond James, Richardson GMP, Canaccord Adams) with a massive book concentrated in ultra high net worth individuals (UHNW) in the North Shore. The guy was genuinely brilliant – he had previous investment experience at a large asset manager and could support every one of his stock picks. He was also an extremely profitable poker player.

The other one was at an old school brokerage arm (Dominion Securities, Wood Gundy, First Marathon) and clearly had a great understanding of markets and investments. He did great for his clients in terms of his recommendations but was also unscrupulous due to blatant omission of data (where a client could save fees under a different strategy he would keep quiet, breaching his fiduciary duty).

Do not hold your breath on one of these guys working for you. Nothing is free in this world and they are far more likely to deal only with high net worth clients while finding the one guy who can actually do this is as hard as beating the market yourself. Also, no guarantee that they can outperform a Fidelity fund consistently.

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Matt
ex investment banking associate
https://www.linkedin.com/in/matt-walker-ssh/

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