Tell me how a person is paid and I'll tell you how that person will behave. I heard that in my management training years ago. I'm not sure who originally said it. That knowledge has served me well for years. It's almost always a question I ask in building any professional relationship. I recommend you ask your advisor the question. I'm going to review the three possible answers. I will also briefly discuss robo-advisors, which promise very low fees for investors. However, low fees don't guarantee better returns for the investor using this model of advice.
Your advisor is either an employee of a financial services company, or an independent contractor working as an agent within a regulated agency. This agent model is very similar to the real estate agent model. Let's look deeper into these employment models.
1. Employee Representative
Employees working on behalf of an employer is typical of the banks, credit unions, caisse populaires, and other mass marketing financial companies. Typically client advice is provided through a computer program, and the advisor changes frequently. The employee is paid to process clients within a particular time frame. Failure to process clients quickly enough results in discipline!
This model creates no loyalty between the person giving the advice and the client. The employee is bound by the employment contract to follow the procedures specified by the company. The penalty is being fired for insubordination. The script being used is designed to put the client into investments which are unproven. See our article on
Bank Portfolios which I strongly recommend against purchasing!
Customer service implications?
The crucial point here is that the person giving the advice has no strong connection to the client. Because of the terms of employment, the advisor simply doesn't care what happens to the client. Their only concern is that the transaction gets completed in the allotted time! There is also no client concern at headquarters where the instructions are programmed for how the client's money is to be invested! This is little more than an assembly line to gather money from less wealthy Canadians! The service is provided to you without charge! This is an example where one gets what one pays for. The reduced performance of the investments offered is extremely expensive for your financial future! This is, in my opinion, a buyer beware option!
Two crucial comments to end this section. The first is that most Canadians find that they have a new person advising them every year or two. The previous person can only stay in this position for a short period of time, knowing that they are not helping the client as much as they could. They get industry experience, then move on to one of the other models discussed below. The second point to note is that those customers who manage to accumulate enough money in their accounts are removed from this model and transferred to a commissioned employee for longer-term client management. IF this employee model was ANY good at all, there would be NO reason to move clients to another model!
2. Commission Models
The other two compensation models involve the advisor taking the risk of working for commission only. Why would anyone do this? Because they have a belief that they can help people more working this way. They also believe they will earn more money than an employee, should they be successful. They are willing to be upon their ultimate success.
That bet takes the form of aligning their goals to the customer's goals. Unlike the salaried employees, the independent contractor representative wants your investments to grow quickly, given your risk-tolerance. He or she is paid a percentage of the value of your portfolio, so your growth increases their pay. That's why an independent agent works hard to find the best investments for you.
Financial companies that look for larger clients tend to charge an account fee annually. The account fee is a percentage of the value of the account, ranging up to 1.5% for smaller accounts. The actual percentage charged depends on the value of the account. Higher value accounts pay a lower percentage. Be aware that any index or mutual funds held in your account will also have annual charges. The annual rate will be lower than funds sold by transaction-paid agents. Both will be much lower that the annual charges for the portfolios sold by the employees.
Companies providing advice to smaller clients, as well as companies providing only transaction handling services, charge a commission on each transaction. Some commissions are a flat fee, based on the total size of the transaction. Some are a percentage of the transaction. Either way, the documentation provided to you should clearly describe how the charges are determined. Those accounts with an advice-based relationship also provide a 1% retainer to the representative to pay for the ongoing costs of client management. Transaction service providers do not provide this advice, so are not eligible for this revenue source.
What About Robo-Advisors?
In the section on employee based compensation, we showed how the priorities of headquarters determines how your money will be invested. This is equally true with Robo-advisors. No one - no person or company - would provide a service without some form of compensation. The compensation optimization occurs within the robo-advisor's computer program. Compensation effects have the potential to impact upon the choices that a potential client might be recommended. At this time, I am unaware of any single company making their selection algorithm open to the public.
Conclusion
A study commissioned by
Fidelity Investments Canada reported that investors working with independent advisors end up with 14% to 30% more money over the long-term compared to the other options. Historical data shows that trying to find the lowest cost rarely provides the best result.
The same study says that 69% of Canadians who work with an advisor say they are closer to achieving their financial goals, in part because a professional makes sure investment choices are based on logic rather than emotion.
Human emotions are powerful drivers of behavior. In investing, those emotions usually drive incorrect behavior. That's why most people but high and sell low in the market. There is compelling data that the long-term financial status of Canadians depends on a strong independent advisor channel!
For other examples of changes we recommend to CIRO to help Canadian investors check out our
Industry Issues blog posts.
