Back in the late 1800’s large risk averse investors held a major portion of their wealth in railroad bonds. This was before sophisticated institutional investment management services were available. Everyone agreed: that was the safest place to keep your money to earn a modest but dependable return. Unforeseen was the emerging importance of the automobile and the resulting bankruptcy of so many railroads. Overdependence on conventional wisdom and following the crowd is only one of a myriad of risks facing investors.
Nowadays there are many more risks that are not necessarily market related. Indeed, many of today’s investment dangers are difficult to detect and manage, but modern investment management firms in Ontario, Quebec, and British Columbia are better equipped to do so.
Your Advisor
In the business of managing your wealth, your advisor’s investment decisions can be driven by career risk. At some levels of the investment business there is a tension between protecting clients’ money and your advisor protecting his or her job. Driving this tension are the monthly sales quotas that many firms expect to be met by their sales force and the pressure not to be wrong on your own. We have all heard advisors say, “well, everybody lost money last year”. To prevent being wrong all alone, many advisors watch what others are doing and flock for safety. The resulting herding action drives prices above or below fair value.
Hidden Fees and Compensation Structure
When purchasing mutual funds or segregated funds (which are mutual funds sold by an insurance company) there are several ways your salesperson may be paid. Oft repeated research has shown that more than a third of mutual fund investors are unaware of the expenses, fees and commissions they are paying. All of these charges, whether they are transparent or not, are ultimately funded by you, the purchaser. If you don’t know what questions to ask or are not prepared to read a lengthy prospectus, in some cases more than a hundred pages, you may never be aware of the money that actually changes hands as the result of your purchase transaction. In addition, mutual funds do not pay taxes and must pay out all their capital gains once per year. As a unit holder you share the tax liability with all other unit holders of any capital gains earned during the year, even if you did not receive a capital gain. For example, if the fund gained 10% from January to November and you purchased units in December, you do not get the benefit of any of the gains, but you do inherit the tax liability because those gains are embedded in the fund. Lastly, the annual embedded fee charged by the fund or insurance company can run as high as 3% or more before any returns get into your pocket. And that expense, for investment management in Toronto, Vancouver, and Montreal, for example, is normally not shown on your regular statements and it is not tax deductible.
Regulatory Bodies
You may never know If your Advisor has been found guilty of breaking the rules as set down by the body that licenses him or her, (ie. MFDA for mutual fund salespeople, IIROC for brokers). Results of an investigation will be posted on the Regulatory body’s website. Victims of wrongdoing and other clients however, are not normally notified. Before agreeing to work with any advisor providing either individual or institutional investment management services, do your homework: visit the relevant website.
Third Party Verification of Prices
Where do your statements originate? Are they produced on your advisor’s letterhead in his or her office? Is the information on the statement independently verified? As your first line of basic safety, when dealing with investment management firms in Ontario, BC, Quebec and other provinces, you must insist that your money be held at an independent custodian from whom you can obtain clear reporting and disclosure on a timely basis.
Fiduciary Duty
A fiduciary duty is the highest standard of care in equity or law. A fiduciary must act at all times for the sole benefit and interest of the ‘client’. The fiduciary can make a profit, by consent, but he must not put his personal interests in front of his duty of care. It is appropriate for you as a client to ask your advisor if he or she has a legal fiduciary duty to you. If not, ask if you can have a ‘fiduciary pledge’ signed. It is a contractual commitment that can be provided by an investment management firm in Toronto, Vancouver, Montreal or any other city that helps ensure that your advisor can’t profit at your expense.