I recently came across a request in a community Facebook group where someone was looking for help finding a Financial Advisor. The request went something like this –
Hi, I was wondering if anyone has any recommendations for a financial planner that works with you, follows up, and gives advice. Someone where you’re not just a number. Thanks
Fair enough, I thought – I suppose this is one way to find a trusted advisor….or, perhaps not.
What followed was somewhere in the neighbourhood of 20 recommendations for ‘Financial Advisors’ from a well intentioned Facebook community. There were also several Advisors who chimed in, offering their services to the group.
The one common thread in the recommendations (and the Advisors who showed up) was that the majority were only licensed to sell Insurance – but were identified, or self identified as ‘Financial Advisors’.
Insurance Brokers Posing As Investment Advisors
The financial services industry in Canada comes with many flaws which puts consumers at risk. One of the greatest deceptions, however, is the misleading and unregulated use of the ‘Financial Advisor’ title. Outside of the Province of Québec, anyone – yes, ANYONE can call themselves a Financial Advisor. The failure of regulators to implement clear rules and regualtions around who can and who cannot call themselves a Financial Advisor has created a minefield for consumers seeking professional financial advice.
Insurance Brokers are without question the single largest group of ‘Advisors’ who have misappropriated the Financial Advisor title for their own benefit. It’s no wonder they seek cover under this handle given the long standing used car salsman stigma attached to Insurance Sales.
Under certain circumstances, Insurance Brokers calling themselves Financial Advisors might be considered reasonable. For example, when an Insurance Broker holds a financial planning designation such as the CFP® (Certified Financial Planner) and offers unconflicted financial planning services. But this is frequently nothing less than ‘professional camouflage’ used to sell insurance products. The real deception begins when Insurance Brokers disguise themselves as Financial Advisors in the name of providing Investment Advice for your RRSP, TFSA or your child’s RESP. Insurance Brokers should never be used for Investment Advice. The reason for this is simple: they are not licensed to offer a sufficiently broad range of investment solutions which allow them to act in your best interests. To the contrary, what you will be offered will frequently serve your Insurance Advisor's interests much more than yours - instead of investing your money in... well...actual investments, you will be sold 'insurance investment products'.
Insurance Advisors are not paid when they provide you with ‘Financial Advice’ - instead they are compensated through product sales. Because their licensing restricts them to only selling Insurance products, they are only able to recommend a small pool of high cost quasi investment products which are actually Insurance contracts – or ‘Insurance Investment Products’. Enter the Segregated Fund - the Insurance Brokers favorite invesment product.
What is a Segregated Fund?
If you find yourself working with an Insurance Agent who is acting as your ‘Financial Advisor’ one of the few investments he’ll be able to recommend will be the Segregated Fund.
Sometimes referred to as ‘Seg Funds’ these products resemble mutual funds in that they hold a managed portfolio of stocks and/or bonds. However, this is where the similarity ends.
Seg funds offer certain guarantees which mutual funds do not offer – this is the insurance element of these products. For example;
1. A 75% to 100% principal guarantee if held to maturity – typically 10 years.
2. Creditor Protection – if you go bankrupt your Creditors can’t access your Seg Fund.
3. No Probate Fees – when you die you avoid probate tax.
Sounds great, right?
When spun by a semi skilled sales person, Segregated Funds can appear as an almost magically ideal investment.
But the meritous features of Seg Funds and their guarantees are dubious to say the least. Here’s why:
1. The fees attached to Segregated Funds are extremely high. All the guarantees associated with Seg Funds come at a very high price. As a Seg fund investor you can expect to pay management fees of about 3.4% per year – however – across all Seg Funds in Canada (there are over 4500) there are plenty that charge well over 4% in fees per year. These fees add up – fast.
Consider for a moment an investment of $10,000.00 in a Seg Fund. If this Fund carries the average fee of 3.4% and you have a reasonable return of 6.4% per year and you hold the fund to maturity (10 years) – here is what your return will look like:
Time Frame: 10 years
Annual Return: 6.4%
Total Return (before fees): $8771.00
Total Fees (3.4%/year): $5201.00
What You Keep: $3570.00
You only keep 41% of your total return – and the longer you hold the fund, you will keep less of your total return.
When it comes to owning Segregated Funds, the one guarantee you can count on is losing >3% of your investment to fees, every year.
We used this awesome calculator, courtesy of Larry Bates to crunch the numbers in this example. You can use the same calculator to help you understand the impact of fees over time for any investment.
2. The principal guarantee only applies if you hold the fund to maturity. This term is typically 10 years, but can be as long as 20 years. That’s right – if after 10 (or 20) years of holding the fund you’ve had a negative return – you will have your original investment (or 75% of your total investment, as the case may be) returned to you.
Sounds wonderful, right? Not quite…
In the history of stock markets, you would have a very difficult time finding a 10 year period where you made a zero return – let alone a negative return. For example, the 10 annualized return on S&P/TSX (the ‘gage’ of the Canadian stock market) has never been less than 2.8% since 1966. In the US, the S&P 500 has only had 1 period since 1939 with a negative 10-year return which was a -3% loss in the period ending 2009.
However (here’s ‘the good’) If you die inside of the 10-year maturity period and the fund has a value below your original investment – your heirs will be guaranteed either 100% or 75% of your original investment, no matter what the stock market has done since you purchased the fund.
3. If you need to access your money and sell your Segregated Fund before it matures you will be subject to punitive withdrawal penalties which start at 7% of your total investment in the first year and decline the longer you hold the fund. Additionally, if you redeem your fund before its maturity date the principal guarantee will not apply.
4. The offer to avoid probate tax is not particularly meaningful, especially given the fees attached to Segregated Funds. If a Seg Fund is held in an RRSP or RRIF account with a named beneficiary, no probate tax applies – so this feature only applies to taxable investment accounts.
How much are probate fees?
Probate fees are paid by your estate when you die and are intended to confirm your will is valid. This tax varies from province to province. If you live in Ontario, for example, you can expect this fee to be about $1250.00 on every $100,000.00 of investment, or 1.25%. Given that every year you will pay, on average, $3400.00 for the same $100,000.00 Seg Fund investment – this turns out to be a very costly ‘benefit’.
Some ‘Warnings’ From The Regulators
Canadian Regulators do offer some insightful information on the pros and cons of different types of investments, including Segregated Funds. The Ontario Securities Commission (OSC) offers some thoughts on Seg funds here, the Quebec Provincial Regulator the Autorité des Marchés Financiers offers similar insights while highlighting the impact of fees.
A Real Life, Cautionary Tale
Since the financial crisis in 2008 we have seen some of the most impressive stock market returns in history. In Canada, the S&P/TSX Composite has served up a 7.23% annualized return over the past ten years. More impressive – the S&P 500 in the USA has provided an annualized return of 13.17% or 245% over the past 10 years.
Meanwhile - over the same period, many Seg fund investors haven't fared so well. This recent story tells of a British Columbia man who unwittingly purchased a Segregated Fund for his children’s Registered Education Savings Plan (RESP). Over the 11 period in which he held the fund his returns were apparently crushed by fees. While the complainant doesn’t specify any losses, he does claim that the fund made more money for the “…fund’s managers and advisors than it had returned to his child.”
How Can You Tell If Your Advisor (or Prospective Advisor) is an Insurance Broker?
For the lay person, it can be very difficult to distinguish between an Insurance Agent and an Advisor who is licensed to build a more balanced and diversified portfolio that can hold Stocks, Exchange Traded Funds, Bonds and Mutual Funds.
In my blog post “How to Perform A Background Check on Your Canadian Financial Advisor” I provide a link to the National Registration Database (NRD). If an Advisor's name appears in the database it means they are licensed with either the Investment Industry Regulatory Organization of Canada (IIROC), the Mutual Fund Dealers Association (MFDA) or a Provincial Securities Commission (such as the Ontario Securities Commission). If their name does not appear in the NRD, and they advertise that they offer ‘Investments’ and ‘RRSPs and TFSAs’ (for example), chances are they are an Insurance Agent.
Alternatively, you could simply ask: “Are you able to offer me investment solutions other than ‘insurance investment products – such as stock, ETFs or Mutual Funds?”
Failing this - feel free to send us an email at firstname.lastname@example.org and we would be happy to assist.
Many professional Financial Advisors are ‘dually licensed’. This means they can offer both advice on Insurance and Investments such as Stocks, Exchange Traded Funds and Mutual Funds. Having a Financial Advisor who is licensed to offer Investments and Insurance separately increases the chance of receiving advice that is at minimum suitable, and ideally in your best interests.
Who are Seg Funds for?
Because of their high management fees, the primary consideration for buying Segregated Funds is to take advantage of their insurance features. Market outperformance should not be expectation. Some of those who these funds might be ‘suitable’ for include;
· Entrepreneurs and business people who want to protect assets from creditors.
· Individuals worried about long term stock market volatility. (GICs may be a suitable alternative).
· Elderly investors who want to avoid probate tax and pass their inheritance on to their heirs quickly.
Protecting You and Your Family
In the same way plumbers aren’t permitted to rewire your house, Insurance Brokers shouldn’t be permitted to provide Investment Advice. I don’t know a single fully licenced Professional Advisor who would disagree with this statement. Unfortunately, Canadian regulators have chosen to favour powerful financial institutions and ignore this vitally important consumer protection issue. The Canadian Financial services industry is replete with riff raff salespeople - until regulators address this situation they can only be seen as puppets acting in the interests of large financial institutions.
Locating an advisor who is most likely to serve your best interests should begin by eliminating the over 35,000 Insurance Brokers who work under the cover of the Financial Advisor title. If you’re looking for comprehensive, Professional Financial Planning, Investment and Insurance Advice, feel free to contact one of the member Advisors profiled here on SeekAdvisor.
Danny MacKay is the founder of SeekAdvisor, a former Bay Street Executive and Industry Insider turned Investor Advocate. If you have any questions or comments about this article please feel free to reach out - email@example.com