Four Themes:

  1. Active investment management, the attempt to outperform a relevant benchmark, has a poor track record, and will continue to have a poor track record, for fundamental reasons.

  2. Cost of investing matters!  It is difficult to keep cost low when you hire an advisor.  The advisor, the advisor's firm, the product provider, the government, and others need to be paid.

  3. Most Canadians have basic financial planning needs.  Financial advisors and planners add value, but the value is not commensurate with the cost for those without complex financial planning issues.

  4. Low-cost, broad-market, passively-managed (indexed) investment funds eliminate the need for investment expertise or experience previously necessary to Be Your Own Financial Advisor.

 

Summary

Active investment management has a poor track record for fundamental reasons.  Investing is a positive sum game and all investors can grow their savings.  There are fundamental reasons why this is and will remain true.  We get better at what we do over time and generations and companies continually reinvest a portion of profit back into the company.  But, investing is a zero-sum game around the market return.  If one or more investors earn a rate of return higher than the market return, it is certain that one or more investors must earn a rate of return less the market return in an offsetting manner.  This is as certain as if one student outperforms the class average, at least one student must under-perform. 

Cost matters.  The higher the cost, the lower the after-cost return and the greater the likelihood that after-cost return under-performs the market return.  There is no cost-free investing but you can drastically reduce your cost factor.  

Cost is misunderstood.  A two-percentage point cost on anything sounds small.  This is not so with investing.  A small percentage point cost on an already small number can be a large cost percentage.  For example, a two-percentage point cost on a six percent pre-cost return eliminates 33% of pre-cost return.  Imagine, to highlight the concept, a two-percentage point cost on a two percent paying term deposit.  Cost eliminates 100% of return.

Financial planning is not difficult.  This is true if you are an employee earning a paycheque or retired.  If you learn a few basic concepts and have a basic understanding of our tax structure and the three main accounts, you have the necessary ingredients to be your own financial advisor. 

A good financial advisor / planner adds value.  But is value commensurate with the cost?  Most Canadians have basic financial planning needs.  An employee who is not in the executive suite, and most retirees, likely have basic financial planning needs.  Financial advisors / planners are trained for complex financial planning cases and their charge reflects this.  The cost of their advice is much higher than the value of their advice for Canadians with basic financial planning needs. 

This website is devoted to help you be your own financial advisor to slash cost and allow the savings to remain in your account and compound.

The Advent of Low-Cost, Passively Managed, Exchange Traded Funds Eliminate the Need for Investment Expertise

Low-cost, broad market, passively managed funds eliminate the need for investment expertise or experience.  An investing novice investing in a product that tracks a market, the S&P/TSX 60 for example, will have superior investment performance than a substantial portion of investment professionals attempting to outperform the S&P/TSX 60 index.  This is pre-cost.  After-cost the investing novice does markedly better.  This is fully explained in the active vs. passive investment management tab.

Why?

Investing is a positive-sum game.  All can have more than their original investment and all can achieve the market return.  But, investing is a zero-sum game around the market return.  All can't outperform the market.  This is an arithmetic certainty. The index must outperform half of all money invested.  Low-cost, broad market, passively managed fund products exist and track the market return less a low cost.  "Low" is around 8 basis points or 8/100 of a percentage point for Canada.  3 or 4 basis points for a US broad market product and under 15 basis points for non-North American broad market products.  Why you don't know about this.

The do-it yourself financial advisor reduces or eliminates five cost centers.  There are six parties involved when a financial advisor or planner is hired.  There is you, there is the financial advisor or planner, there is the financial advisor’s or planner’s firm, and there is the product provider (think mutual fund company).  These are the big four.  There is the government in the form of GST, PST, HST and the hidden cost of regulation and finally all the outside services the product provider must hire such as auditors, lawyers, record keepers, traders, board of directors, and others.  These are outside independent services that are paid from money in the fund; investor's money.

 

When all these parties are paid, the cost to you can be over two percentage points per year.  Two percentage points is a tremendous performance drag over the course of a lifetime.  See the long term consequence of a 2 percentage point performance drag.  Many investment products have cost well over 2 percentage points.  Cost lowers return.  Stated differently than above, an investment that delivers a 6% return after-cost and has a 2 percentage point cost generated 8% pre-cost.  Cost removed 25% of return.  An investment that delivers a negative 6% return after-cost and has a 2 percentage point cost generated negative 4% pre-cost.  Cost increased the loss by 50%.  Cost matters! 

How do you pay, what do you pay, and what are you buying?

Here is a chart from 2011.  Enlarge and focus on the table in the bottom right corner to see the average annual pre-cost returns available to passive investors from 1950 to 2011.  This is pre-cost but cost is low for the passive investor.  Subtract 10 or 15 basis points and this is approximately what you would've received.  This is what happens when the cost centers are fired.

 Watch what Warren Buffet says about index investing.  The relevant part starts around 1:40 into the video.

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  Canadians pay too much for financial advice and are poorer for it.  There is a better way.

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