The investment fund industry would have you believe that banning embedded commissions – or trailer fees – on mutual funds will create an advice gap. The thought being that a commission ban will cause thousands of financial advisors to flee the industry and leave small investors, those with portfolios under $100,000, without access to quality financial advice.

This purportedly was the case in the U.K., where the number of financial advisors fell from 40,000 to 31,000 after fees were unbundled from investment products in 2011.

Here’s the thing. This advice gap argument is bullshit because small investors already get screwed. Let me explain:

Banning Commissions Won't Lead To An Advice Gap Because Small Investors Are Already Getting Screwed

The so-called advice gap

The typical way for a small investor to get started is to meet with a financial advisor at their bank or at an investment firm such as Investors Group, Edward Jones, Sun Life, or *shudders* Primerica.

A good advisor will assess the client’s overall financial situation before diving into investment recommendations, however ain’t nobody got time for that when they’re trying to meet company quotas and sales targets.

Instead, advisors set-up their clients with cookie-cutter portfolios of mutual funds suitable to their risk tolerance and encourage them to make regular automatic contributions. The mutual funds likely come with management expense ratios (MER) of 2 percent or 2.5 percent, from which the advisor is paid an ongoing trailer fee or commission of between 0.25 percent and 1 percent.

The investment fund industry says the trailing commission is the most effective way for small investors to receive financial advice. This may be true, to some extent, but the problem is most small investors receive little to no advice at all. Instead, they maybe get a phone call once a year during RRSP season encouraging them to make a contribution.

‘Our financial adviser is such a nice man. Every year he takes us out for a wonderful dinner. I wish we could pay him in some way.” This is an exact quote from a friend’s mother. It’s a classic example of a Canadian investor not knowing what he or she is paying. – Steadyhand’s Tom Bradley.

The focus is 100 percent on product sales, not advice. But an investment portfolio is not a financial plan. Young investors, and those with modest portfolios also need help managing their cash flow, creating and sticking to a budget, prioritizing their short, medium, and long-term goals, paying off debt, optimizing their taxes, and reviewing their insurance needs.

These things are not being offered to small investors now. The advice gap already exists. Now let’s say regulators finally implement the long-awaited commission ban and it plays out just like the investment fund industry predicts. Which advisors will leave the industry? Perhaps the ones whose sole business model relies on getting hundreds of small investors to pay ongoing trailer fees on their mutual fund investments.

Is this such a bad outcome for small investors? Hardly. Right now they’re paying some of the highest fees in the world for underperforming mutual funds without getting any proper financial planning advice.

Thankfully, while regulators have been mulling this ban for more than 20 years (seriously), new options have entered the market to make investing easier and more accessible for all types of investors.

Robo-advisors are disrupting the traditional investment management business, allowing investors to build a low-cost portfolio of ETFs and rebalance it on the cheap. Wealthsimple, Canada’s leading robo-advisor, recently announced that it has over 30,000 clients and more than $1 billion in assets under management.

Online discount brokerages cater to the do-it-yourself investor and these robust services have become cheaper and easier to navigate in recent years with more of a focus on user experience.

Finally, the emergence of fee-only financial planning not only shows that Canadians are willing to pay upfront for financial advice, it also highlights the importance of offering conflict-free advice that is not tied to product sales.

Final thoughts

It’s clear to me that the ‘advice gap’ is simply a desperate attempt from a dinosaur industry to keep things status-quo. Understandably, there’s a lot at stake. As of April 30th, 2017 Canadians held $1.42 trillion in mutual funds.

Yet there’s overwhelming evidence that trailer fees – the current way most financial advisors gets paid – create a conflict of interest and lead to worse outcomes for investors.

If banning embedded commissions means that thousands of advisors leave the industry then so be it. It’s likely this is the bottom rung of advisors – the order takers and product pushers – that don’t offer much value beyond slinging expensive mutual funds.

Any good advisor worth his or her salt provides financial planning advice in addition to portfolio management and investment advice. But odds are these advisors only work with high net-worth clients. For the rest of us, I recommend a two-pronged approach:

  1. Use a robo-advisor to manage your investments.
  2. Hire a fee-only financial advisor to create a financial plan for you.
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13 Comments

  1. Paul on June 5, 2017 at 6:55 am

    I retired from the industry you constantly crap on over 5 years ago. You tend to label all mutualfund/sales advisors with the same criminal like comments. You miss out on some very important points though. Number one is many of these individuals are providing a full level of service thanks to an improved level of training over the last 10-15 years and they are actually compensated much less than the fee for service people you treat in a god like manner. Two, you assume they are rip off artists and the fee for service people are saints. Three, you forget in most cases, these are the folks who get clients started on building education plans,saving for retirement and other important issues. Most people do not just pick up the phone and say please come see me, I need to make smart financial decisions. Yes fees are high, and maybe your comments need to be directed against the manufacturers. Time to stop insulting the many highly educated people who work in the industry, or you you think its important to just try to increase your readership.

    • Echo on June 5, 2017 at 9:38 pm

      Hi Paul, I’m picking on the industry, not the advisors themselves. Of course there are good advisors out there but the industry and its compensation structure is set up in such a way that all of the focus is on investment products rather than financial planning. The result is that investors get short-changed and later end up looking for help to try and untangle themselves from a mess of high-MER funds, group RESPs, and whole life insurance plans that were sold to them when they didn’t know any better.

      • jon on June 6, 2017 at 4:49 pm

        Paul, I’m not sure if you are trolling or actually trying to add value to the conversation. I’m not sure if you are in Canada, the US, or the UK but I’d be interested in hearing your thoughts on the DOL Fiduciary Rule.

  2. john on June 5, 2017 at 9:38 am

    A big part of the job is finding clients. Clients who don’t know or think they can better invest their money or reduce their taxes, or get Financial stategies and discipline to reach their objectives.

    Not to take into account the time and energy consumed to find clients, explain them how finance works, educate them… is missing the point ! This activity has to be paid and the only way is in embedded commissions.

    Of course rich people don’t need advice, but they already have a lot of options to pay very low fees and they use them.

    • Echo on June 5, 2017 at 9:43 pm

      Embedded commissions is one way to get paid but it’s not the only way. Proper financial planning advice is worth money, just like accounting and lawyer services. Attracting clients will still take a lot of work, no matter what compensation model is used. Unbundle the advice from products and give clients an objective look at their finances so that they can make informed decisions on their investments and other needs.

  3. Robert Gignac on June 5, 2017 at 12:13 pm

    I’m not against the robo-advisor model – there are many it will work well for – but as you stated in the article “Young investors, and those with modest portfolios also need help managing their cash flow, creating and sticking to a budget, prioritizing their short, medium, and long-term goals, paying off debt, optimizing their taxes, and reviewing their insurance needs.” – just how are those young investors getting these needs met via a robo? Yes, there is a 2nd prong in your approach “Hire a fee-only financial advisor to create a financial plan for you.” – but which young investors are willing to spend that money (which they already don’t have – due to their lack of cash flow, lack of budgeting and debt?)

    • Echo on June 5, 2017 at 9:49 pm

      Hi Robert, I’m convinced that money coaches and fee-only planners can fill the void by offering basic planning on the cheap for those who just need some help with debt management, budgeting and cash flow, goal setting, etc. The service can scale-up as financial needs become more complex.

      Plenty of thirty-somethings, even those who are in debt, are willing to pay for some light advice to get them on track financially.

  4. John on June 5, 2017 at 2:48 pm

    Contrary to a previous comment I too retired from the financial services industry and can report from personal experience that many in the industry treat small investors as commission generators and give them as little of their attention as possible. My advice to small investors is to take advantage of robo services and fee only advisors.
    We need much more attention paid to financial literacy in this country

  5. Keith Cowan on June 5, 2017 at 4:06 pm

    The ignorance of clients is overwhelming. I wonder how the industry can be regulated to overcome that?

    • Echo on June 5, 2017 at 9:56 pm

      Keith, it’s true that we do need more focus on financial literacy at every age and stage, however regulation is also needed to give people a fighting chance.

      As Rob Carrick once said, “Buyer beware? That’s a little Darwinian for me. I’d prefer not to live in a financial world where you get your bones picked clean if you fail to read the fine print.”

  6. Keith Cowan on June 5, 2017 at 5:59 pm

    Maybe just get them to select Morningstar Mawer104 which has 15 year performance of 7.97%. Hard to not like it.

  7. Owen @ PlanEasy on June 6, 2017 at 8:38 am

    The advice gap is real and it’s the reason I started PlanEasy. Our goal is to provide young individuals and families with a very inexpensive way to plan their finances. There’s no sales goals or commissions. Just 100% fee-only advice.

    Many fee-only planners would love to provide services to those with net worth below $100,000 or negative net worth but it’s not financial feasible for them. Automating part of all of the process will make this possible. Along with services like Mint, Questrade, Wealthsimple, PCFinancial and Tangerine it will be possible to manage all of your finances and financial planning for less than the cost of a monthly gym membership.

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