Monday, January 30, 2012

All Those With Bank Advisors: Beware!

I am a DYI investor. I've done and continue to do enough reading and have a simple enough financial situation that I feel comfortable with this. This will not always be so and there will be a point at which I will seek out professional help. But the last place I will go is my bank. Going to a bank advisor is one of the worst decisions you can make for your financial health, and over the course of 3 posts, I am going to show you why.

First we will discuss the impact of fees on portfolio performance. The second and third posts will discuss two tactics often employed by bank advisors that not only can I not understand but I believe they could never truly justify: the opportunity costs of lump sum investing and the devastating impact of chasing performance.

When I talk about going to an advisor for myself, I mean individuals who have no vested interest in the PRODUCTS they recommend but instead in the ADVICE they recommend. Bank advisors are handicapped by a limited product portfolio and, as such, you must purchase mutual funds from their bank. In some cases they will broaden the horizon somewhat, but they are still selling you actively managed mutual funds, a sure fire way to fall well short of expected returns (if you need me to explain why, look through some of my past posts or just comment, and I shall oblige with an appropriately indignant rant). Furthermore, most bank advisors have risen up from within the banks lower ranks, taking in-house training courses and learning "on the job". They have no more basic financial education than you or me. Of the 3 advisors I've already encountered in my travels by virtue of necessity in setting up my index investing account through TD, 1 was so delusional about actively managed mutual funds it was clear she was a lost cause, 1 looked at my situation and recommended a cookie-cutter fund-of-funds with an expense ratio of 2.5%, and 1 didn't know what index funds were. And I've heard enough stories from friends and family and in the media to know my experiences were not exceptional.

But if they are so detrimental to financial success, why does everyone use them? Why have the best advisors, that is, fee-only financial planners who don't sell products but advice, not caught on with the general public? One cynical answer would be that the big banks have a huge vested interest in promoting their advisors because that sells their products, which makes them money and brings more assets under their control. All of these are important factors guiding the success of their business, a pursuit that you cannot hold against them. But more pragmatically, fee-only advisors cost money. At least in the traditional I-can-see-the-money-leaving-my-bank-account sort of way.

But what if I were to tell you that bank advisors actually cost you a heck of a lot more than you think?

I'll admit, I've suffered the same pain of loss that comes with thinking about handing over $1500-2000 to a fee-only financial advisor for a comprehensive financial plan. But a simple hypothetical scenario will expose the fallacy of this reasoning.

Let's say I'm 30 and I have already built up a nest egg of roughly $100 000. For reasons beyond my control, I can no longer afford to save anything for retirement. I need this sucker to grow as much as it possibly can. Given my situation, I am holding off on retiring until 65, giving me a 35 year investment window. One hill I will die on is my asset allocation and so I tell my financial advisor I don't care what s/he puts me in, I want it to represent 40% fixed income and 60% equity.

To arrive at the numbers below I used my favorite online tool, This tool looks at all the American stock market data from 1871-present. When you enter your retirement time horizon as 35 years, how much you start with, and how much you plan to withdraw each year, it runs those numbers through every 35 year period in that time set. That is a lot of data!

In the first scenario, I walk into a bank. The individual dumps me into some bank-brand mutual funds. Considering an average MER of 1.6% (roughly the average of the big banks, particularly RBC and TD), at age 65 my portfolio would range from $125 757 to $628 782, averaging $287045. (As an aside: If you use other groups like Sunlife Financial or Investors Group, your MERs are likely closer to 2.5% and there are usually nasty load fees. At least the banks usually sell no-load funds.)

In the second scenario, I visit a fee-only advisor. They put me into passive index funds with an average MER of 0.4%. In this case my portfolio would be worth anywhere from $189 881 to $949 404, averaging $433 846.

The average difference is $146 801. What is my point? For one, fees matter. That small difference in management expense fees of 1.2% costs you almost $150 000 over 35 years. For two, bank advisors aren't free. You just paid for their advice with that money. How much could you have spent on a fee-only advisor each year over those 35 years for the same price? $4200. The most expensive I've come across so far is $2500/year and that was for a very comprehensive service.

So, you see, just because you aren't scratching a cheque or pulling money out of your account to pay that bank advisor, doesn't mean his advice is free. It comes at a substantial price. And the above considers that the advice and service they give you over your retirement saving years will produce as good results as that provided by a fee-only advisor. The above projections used the exact same portfolio with the exact same stock market return data. The only difference was the management fee paid on investments. In the next two posts, you will see that there is a pretty good chance that these fees aren't the only money you'll lose before retirement by employing a bank advisor.

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