Breaking Up Is Surprisingly Easy to Do

 

If you already have an advisor (or a commissioned salesperson who you refer to as an advisor) and they focus on picking expensive, actively managed mutual funds for you – and are not producing value for money – then you may wish to fire your advisor and become a self-directed, do-it-yourself investor using what you've learned in this book.

Approaching them to leave may be awkward, especially as many advisors build very personal rapports that don't seem like you're in a salesperson-customer relationship. The point-of-view is so deep that many don't call it “switching accounts” or even “leaving” but rather “breaking up.”

Indeed, the hidden nature of mutual fund fees is a clever bit of social engineering, as this hides the commercial aspect of the relationship, and makes it less likely that a customer will consider the potential conflicts-of-interest or critically question the advisor. Once your eyes have been opened to how your salesperson is compensated, and how large an effect a fee of a percentage or two can have on your long-term wealth then hard feelings may result: the monetary aspect becomes a “betrayal” of what many had previously (subconsciously) considered something akin to friendship. So, it's time to leave and set off to invest on your own.

If you attempt to confront your advisor then they will have an opportunity to try to dissuade you from an index approach, or attempt a guilt-trip. There are a number of common arguments advisors use. These often have logical fallacies, or sound good but aren't backed up in the data. Note that because they are primarily in a sales role, your advisor will likely make these appear compelling (at least as long as you are within their reality distortion field and don't have the time to research or critically evaluate the argument and evidence).

If you're about to switch to passive index investing, you may find that the goalposts can be moved by your salesperson, with the pitch that perhaps they can deliver “absolute returns” or “lower volatility” than an index approach. That can be a persuasive argument, as can the thought that some human agency is tending to your portfolio. Even though humans make all kinds of critical errors, it can be a reassuring thought next to the notion that you've handed over your investments to a passive sampling of global capitalism.

One fact I like to remind people who are having trouble leaving their commission-based advisors of is that, by and large, an advisor gets paid for being a good salesperson and not for being a good stock-picker. Their arguments will sound persuasive if they are good at their job. Remember that many pension funds have looked at the evidence and decided to follow an indexing approach themselves.

Some common arguments they may try to sway you with include:

• That a skilled advisor can choose the portion of funds that will, through luck or skill, beat the index net of fees.

• The evidence shows that this is usually not the case.

• That active management can help avoid losses and protect your money in a market crash.

• Funds underperformed their benchmarks just as much in 2008/2009 as they did in other periods; active management if anything encouraged more selling out at the bottom and delayed buying in as markets recovered.

• That you wouldn't want some mindless index algorithm in control of your money, like a driverless car – an appeal to control.

• Though having a human in charge of your funds feels comforting, it is a demonstrably weaker strategy, with higher costs, salaries to pay, and more room to make mistakes.

• That people who use advisors are wealthier.

• This is true but is because people who have money are more likely to go to an advisor than because advisors make people wealthy. Think about private jets: people who use private jets are more likely to be wealthier, but that’s not because private jets are generating the wealth.

• That they offer other services like planning.

• This may be true, however many salespeople focus on investment product selection and do not provide their clients with comprehensive financial plans or other services like counselling through market turmoil – in other words, they are not offering value for money. The big banks are particularly bad at this as you may never see the same person twice. Be sure that you are getting value for your money: you can invest in low-cost funds, pay by the hour for a planner to fill in the other services, and still come out with significant savings.

Fortunately, breaking up is surprisingly easy to do. Once you make the decision, you never have to see your advisor again: there is an established process in Canada to have your new bank or brokerage “pull” your investments over from your old advisor. You can elect to do this in the process of opening your new account by just checking a few boxes and filling in your old account information in the application form, or contact a representative to help you do it after your account is open. If your old firm charges a fee to transfer out and/or cancel your accounts, then your new firm may pay this for you. Be sure to ask about that with the new firm if that applies to you.

Keep in mind that the firm you are moving to wants your business, so they will help make the transition as easy as possible for you.

Transferring directly from your old firm, directed by your new firm, is the way to go especially if you have an RRSP or some other registered funds. If you attempt to move funds yourself, you may accidentally withdraw from a registered account and face a tax bill and lose the contribution room. A proper account transfer is the only way to do it.

For the TFSA however, the situation can be a bit different. Some companies charge a transfer-out fee (up to $150 in some cases), but often do not charge a fee to withdraw cash on your own. Because you get TFSA contribution room back in the following calendar year you can do what's known as the “TFSA shuffle”: withdraw from your old TFSA, hold the cash/investments in your non-registered accounts until the year ends, and then contribute to your new TFSA in January.

If you have funds with deferred sales charges (DSCs) then you may need to take more care in your separation. These fees can run up to 7% or more if you sell earlier than the fund company allows. Given the magnitude of this, it may be worth waiting for a few years to ride out the DSCs, even if you're paying higher ongoing MERs. If you ask, your old advisor will provide a table indicating which funds have DSCs and the terms associated with them, which can help you plan your exit. For instance, if you're allowed to sell up to 20% of your funds per year without paying a fee, then do so, and work your way out. If the DSC is comparable to the MER – as can happen with DSCs that slowly get reduced rather than sharply ending – then it may make sense to just rip the bandaid off and get into low-cost products.