Your Money’s Worth

The landscape for financial advice in Canada is confusing at best.  There are many designations that range from essentially mutual fund salespeople to highly-skilled fiduciaries.  Author Shamez Kassam aims to explain it all in his book Your Money’s Worth: The Essential Guide to Financial Advice for Canadians.  This book has a lot of useful information about financial advice (mostly for wealthy people), but understates problems in the industry, and contains repeated pitches for readers to use a financial advisor.

The main topic areas covered are the various types of advisors, investment products and principles, insurance and estate planning, and a set of forms designed to help evaluate and choose a financial advisor.  The emphasis in this book on advising the wealthy starts early in the introduction: Advisors “offer big-picture concepts and solutions, and then coordinate with your accounting and legal professionals.”  There is some information relevant to people of modest means, but the book is primarily aimed at the kinds of clients advisors prefer: rich ones.

In discussing specific parts of the book, let’s start with some good parts.  In a discussion of bond ratings agencies: “Keep in mind that ratings agencies are paid by bond issuers.  If you’re thinking this creates the potential for conflict of interest, you are correct.”  Kassam goes on to explain how this conflict can lead to some bonds getting unreasonably high ratings.

On fee disclosure: “additional transparency requirements were implemented by regulators so that investors can see the amounts paid to dealers.  However, the actual fees charged by the mutual fund companies to manage the investments are still not fully transparent.  The move to enhance transparency by regulators is a welcome step in the right direction, but it’s only a half measure.”

Mutual funds that charge high fees for active management but are really index funds are called closet index funds.  “In the industry today, very substantial sums of money remain invested in active management strategies that are really closet-index type investments.”

On fund fees, “Expense ratios are the most powerful predictor of fund performance.”  While investors chase funds with high recent returns, they’d be better off choosing funds with low fees.

There were several parts of the book where problems with the financial advice industry were understated.  On fee disclosure, Kassan claims that the industry “has taken bold steps to enhance disclosure” with changes that were known as CRM2.  An alarming proportion of investors still think they don’t pay their advisors.  Disclosure of costs remains poor.

On embedding costs in investment products, “there is nothing inherently wrong with the embedded-fee structure, as long as proper disclosure is provided and costs are clearly understood.”  The problems are that embedded costs exist to hide costs from investors, and it’s a rare investor who clearly understands the costs he or she pays.

On segregated funds offered by insurance companies with principal guarantees and life insurance features: “The additional features result in fees that are typically higher than mutual fund fees.  Segregated funds definitely have a place in some clients’ portfolios, but I have seen instances where clients invested in segregated funds but didn’t need the additional features the funds offer, meaning the clients paid higher fees than they really needed to.”  Very few investors in seg funds need these high-cost features.  Costs are often more than 3% per year.  Over 25 years, this consumes a stunning 53% of the investor’s savings.

On fee arrangements where investors pay an explicit fee to an advisor and also pay fund costs: “if an advisor is charging an annual fee of 2% and then using mutual funds for the entire portfolio, it may be a problem.”  This describes an arrangement with outrageously high fees.  It warrants more concern than that it may be a problem.

On the impact of fees, Kassam begins with an extended commercial for the value advisors bring and complains about “articles in the media criticizing the financial industry for supposedly charging unjustifiably high fees.”  Then he gives an example of an investor making 7% (before costs) over 10 years on a $100,000 investment.  With fees of 2.5%, 1%, and 0.25%, the final portfolio values are $155,297, $179,085, and $192,167, respectively.  It’s good to focus on fees, but 10 years isn’t long enough to truly see the corrosive effect of fees.  Extending this to 25 years, the final portfolio values are $300,543, $429,187, and $511,914, respectively.

A problem mutual funds have had is that advisors want to get paid up front for selling the funds, but investors don’t like losing 5% of their money off the top.  The brilliant solution was to try to hide the up-front payment with back-end loads.  This means that if the investor sells within 7 years, he or she has to pay a fee.  Combine this with a high yearly fee, and mutual funds are sure to get the initial payment to the advisor back from the investor either over time or with the back-end load.  Kassam claims that “back-end loads can work for certain investors.”  They work best for advisors and mutual fund companies.

“Novice investors who try leveraged ETFs are often disappointed with the results.”  With inverse ETFs, “some investors may be disappointed with the results.”  The truth is that few investors understand the volatility drag of such ETFs, and they should steer clear.

There were other parts of the book I didn’t like for reasons other than understating problems in the financial advice industry.  Kassam mentions the oft-quoted Vanguard study that “concluded that the overall value of advice can be up to approximately 3% of investment assets annually.”  However, this is only for excellent advisors when matched with clients with little knowledge.  Most advisors are far from excellent.

In a section on the styles of stock investing, only active approaches were mentioned: fundamental investing and technical analysis.  The best option for most investors, index investing, wasn’t mentioned in this section.

“When markets are dropping significantly, (a ‘bear’ market), active managers can protect the downside and outperform by having more cash in a portfolio or by being in more defensive sectors of the market.”  All the research I’ve seen shows that mutual fund managers don’t achieve this.  They actually hold more cash after markets have gone down.

Kassam mentions DALBAR studies supposedly showing that investors hurt their returns through bad market timing.  However DALBAR’s methodology makes no sense.  If they are measuring your portfolio returns over the past decade, and you received an inheritance a year ago, they conclude that you used poor market timing when you failed to invest that money at the start of the 10 years.

On picking stocks, “Your returns will be directly correlated to the time you are able to put toward selecting investments and your ability to control your emotions.”  All the evidence says this isn’t true about the time you put into stock selection.  Average investors are so much less capable of picking stocks compared to professionals that their picks will be essentially random no matter how much time they devote to the task.  Typically, these investors will make less than an index due to trading costs and poor diversification.

In a discussion of annuities, Kassam classifies inflation indexation as one of the “bells and whistles” you can add to an annuity contract.  A big problem with annuities is that people often don’t understand how corrosive inflation can be over multiple decades.  They buy an annuity with an acceptable monthly payout, say $2000, and long after it’s too late to do anything about it, inflation has cut the buying power of these payments in half.  Inflation indexation is important.

While this book has some good information for investors wishing to understand the financial advice industry, there are too many questionable parts to recommend it to readers.