Commission-Based Advice and Suitability: A Dangerous Combination for Canadian Investors

The average Canadian investor has little clue how their financial advisor gets paid, or that their advisor is only obligated to provide advice and product recommendations that is suitable, but not necessarily in the best interests of their clients.

Commission-based advice

Why does this matter? Commission-based advice leads to conflicts of interest. Namely, advisors who sell mutual funds are motivated by trailer fees, which is a commission paid by the mutual fund company to the advisor.

According to a recent study by York professor Douglas Cumming, there are three ways that trailer fees cause harm to investors:

  1. More money is steered towards mutual funds that have higher trailer fees;
  2. Money is less likely to be taken out of mutual funds with poorer performance among funds that pay higher trailer fees, and;
  3. Mutual funds that raised their trailer fees experienced a drop in performance, while funds that lowered their trailer fees experienced a rise in performance.

Canadian securities regulators have been mulling a ban of trailer fees or embedded commissions for over two decades. The mutual fund industry, as you can imagine, is vehemently opposed to such a ban.

Why, you may ask? Canadian investors hold more than $1 Trillion in mutual fund investments and pay over $5 Billion in trailer fees every single year.

Commission-based advice and Suitability: A Dangerous Combination for Canadian Investors

Suitability vs. Best Interest

What about suitability versus a best interest standard? Most advisors in Canada are held to a suitability standard, which means before recommending an investment he or she must demonstrate that it’s appropriate based on their client’s risk tolerance, goals, and experience.

Best interest, on the other hand, is a higher standard of care where an advisor must “deal fairly, honestly and in good faith with its clients and act in its clients’ best interests.” Regulators are currently consulting on a proposed best interest standard of care that would be based on five guiding principles:

  • Acting in the best interests of the client;
  • Avoiding or controlling conflicts of interest in a manner that prioritizes the client’s best interests;
  • Providing full, clear, meaningful and timely disclosure;
  • Interpreting law and agreements with clients in a manner favourable to the client’s interest where reasonably conflicting interpretations arise; and
  • Acting with care.

One question: How is this not already in place? Anything short of this is simply a disservice to Canadian investors.

A dangerous combination

Conflict of interest and a lack of regulatory control is a dangerous combination. Here are a few examples of how Canadian investors might be harmed in this environment:

You might pay higher investment fees – Canadians already pay some of the highest mutual fund fees in the world. And Dr. Cumming’s work shows that advisors are more likely to direct your investment dollars into mutual funds that pay them the highest commission.

For example, when given a choice between a Canadian equity mutual fund with a management expense ratio of 2.18 percent, and a Canadian index fund with an expense ration of 0.42 percent, most commission-based advisors would choose the higher fee fund.

That recommendation would be “suitable” for any medium-to-long-term investor who can handle the ups-and-downs of the stock market. But is it in the client’s best interest? Not a chance! Overwhelming research shows that higher fees lead to poorer investment performance.

You could get conflicted advice about your pension – Some employees are still lucky enough to have a defined benefit pension plan. If you leave your job, you have to decide whether to take the commuted value of your pension and place it into a locked-in retirement account, or leave it in the plan and collect a reduced pension upon retirement.

Ask your commission-based financial advisor which option you should choose and it’s likely he or she will recommend taking and investing the lump sum. Why? Because your advisor stands to gain from the commission and fees charged to manage your funds. If you keep it in the pension plan, your advisor won’t see a dime.

To be fair, it may be smarter to take the commuted value. But understand that your advisor could be motivated by the idea of a lump sum investment and is certainly not compelled to disclose that conflict to you in advance.

You might get conflicted advice on CPP – Canadians can decide to take a reduced Canada Pension Plan benefit as early as age 60, or holdout for more money by delaying to age 70.

What might your commission-based advisor think of that choice? Take the money early, he or she might argue. There’s no guarantee you’ll live to 95. Invest it with me and add to your retirement fund (and my commissions).

Again, without a best interest standard of care this advice may be harmful to retirees.

You could be encouraged to use leverageBorrowing to invest is a double-edged sword because you can amplify your losses just as quickly as your gains. Leverage, therefore, should only be used for the most experienced investors who understand the risks involved.

Unfortunately, your commission-based advisor might view your leverage and risk-taking as a way to line their own pockets. One strategy might be as simple and innocuous as an RRSP loan, which is a win-win for the advisor with a loan on the books and additional capital to invest. A little more dangerous strategy might see you tapping into your home equity to invest using something called the Smith Manoeuvre.

Final thoughts

Investors fill out the ‘Know-Your-Client’ form to gauge their risk tolerance and investing know-how. The environment when filling out the form is calm and the investor might eagerly overstate his or her knowledge and temperament.

Unfortunately, the form does little to prepare you for what a market crash feels like when you’re invested 100 percent in stocks. What it might do, however, is give your advisor permission to put your capital into risky investments that generate high commissions and generally lead to poor returns.

That’s why the current commission-based advice and suitability standard regulatory environment is a dangerous combination for Canadian investors.

A best interest standard, coupled with a ban on trailer fees, could see all but the most risky and experienced investors placed into low cost, broadly diversified ETFs or index mutual funds to help them reach their investment goals.

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  1. Steve Bridge on December 5, 2016 at 9:30 am

    Well said, Robb. If we keep beating this drum long enough and loud enough, real change that is in Canadian’s best interest just might come!

  2. Kathy Your Net Worth Manager on December 5, 2016 at 10:55 pm

    Great points Robb, based on the number of calls I receive a minority are starting to wake up to the fact the system is not run to their benefit. Fees will become a bigger issue as we start to see them on statements 2017 ( although its still not enough info ) I appreciate you flagging the bias about advice on CPP, whether to leave a DB pension decisons. Recently I have seen advisors tell people they cannot take money out for cottage repairs / travel etc and when we run a plan they can. The investment rep who said they couldnt had done no real retirement or income forecasting , just said NO. Clearly didnt want the $700k to drop to $600k and make less. Makes me mad when people have worked so hard for what they have.

  3. Jeff on December 7, 2016 at 12:31 pm

    Hey all…I’m one of those planners mentioned above and thanks for painting all of us with “the same brush”. Yes, there are definitely those described as above. However, not all of us are. I for one feel taking CPP before 65 is ludicrous! Using RRSP proceeds from retirement to 65 is a great time to get registered money out prior to having more income from CPP and OAS at 65 (or older). I’m seeing too many client dying with TOO much money in registered assets, that then get taxed and collected by CRA. DC pensions sometimes do make sense to move especially if one spouse has a DB to offset the other ones DC. That way you can have your cake and eat it to.

    Oh yah, on the topic of fees, I feel it’s always funny to compare the average MF MER to an index ETF. Keep in mind there are commissions both in and out of ETFs, and quite often other account fees or advisory fees that are taken into account when comparing MERs. Also what is the cost of advice? Stats show that people working with advisors have far more assets than those without. Possibly because advisors manage emotions, and interactions, as well as people’s money. So…make sure you’re always comparing apples to apples when doing comparisons.

    • Echo on December 7, 2016 at 1:51 pm

      Hi Jeff, this is definitely a case of “hating the game, not the player.” Of course there are great advisors out there, but the system is not designed to look out for the best interests of clients.

      Even when you add in the cost of trading (which at some brokerages is free to buy), most ETFs are still a tiny fraction of the cost of holding an average equity mutual fund. Add in a robo-advisor or a human fee-only advisor and the vast majority of the time you’re still saving money.

      As for the “study” that suggests people working with advisors have more assets than those who don’t use an advisor, please…that’s like saying people who drive a Mercedes tend to have more money than those who don’t drive one, therefore driving a Mercedes makes you rich! Correlation doesn’t equal causation.

    • Denis on December 11, 2016 at 8:08 am


      Are you serious that you are defensing the obscene MF MER in Canada. I found out early on that MF are a scam in that they take 2% off the top so already you are 2% behind the game to start. Add 1-2% financial advisers fees etc and how can anyone win this game.

      ETF have been a breath of fresh air to ordinary advisers if they don’t have the time to find a few good dividend paying big cap stocks and certainly there are few good ones in Canada vs rest of the world.

      The only reason to have an adviser IMO is to save yourself from yourself, I grant you that. Individuals are at the whim of their emotion, latest fad and it is true that they tend to buy high (fad, momentum) and sell low (emotions, stress,..). Being successful is a lot of hard work that few can devote and lots of get rich quick out there.

      This is a debate that can go back and forth with valid arguments but many ways to do better than using advisers (how do you know which are the good ones as they are all good salesmen?) such as ETF (easy with SPY US to FEZ Europe for example) to Blue chip dividends (moderately easy) to more difficult strategies.

      My 2 cents worth 1 cent

  4. Geoff Murray on December 15, 2016 at 5:45 pm

    And yet, investors don’t seem to mind fees “Last September, IFIC released statistics on a survey by Pollara showing that mutual fund investors value the advice they receive from their financial advisors, with 95 per cent saying they can trust their advisor to provide them with sound advice and 88 per cent indicating that the advice they get leads to better returns. On top of that, a strong 91 per cent said they receive value for the money they pay their advisor.”

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