|How to avoid getting ripped off by financial
Monday April 30, 2012
When financial advisors first get into the business, we basically
agree to run our practice by certain common-sense rules and
abide by a demanding code of conduct. But some advisors stray
from the rules, and the worst ones make the headlines. That
gives the entire industry a bad name, which is unfair, because
the vast majority of advisors are hard-working, highly ethical
individuals who take their responsibilities as seriously as
any other professional. It’s not often easy to spot the bad
apples, so in this article, I’ll provide some examples of practices
that are frowned upon, unethical, or just plain bad business.
If you spot any of these, all your alarm bells should go off.
Churning and the DSC option
There are two main methods of churning – that is, buying and
selling securities simply to make a commission. Churning mostly
occurs in a stock account where a broker is making countless
trades simply to generate commissions. It can also occur with
mutual funds, where an advisor recommends purchasing a fund
with a deferred sales charge (DSC) when a previous DSC fund
has either matured (all units are fee-free) or almost matured.
If a DSC fund has almost matured and has $1,000 left in fees,
a favorite play of an unscrupulous advisor is to either let
the client eat the $1,000 or rebate it back to them, while he
earns $4,000 (for example) on the DSC from the new fund(s),
leaving him or her with a tidy profit for simply shuffling the
When advisors make fund switches, it is called “servicing,”
and your advisor already gets paid for that. Servicing is part
of the job. Locking clients in for a second time at a hefty
additional fee is not.
Almost every mutual fund pays financial advisors a “trailer
fee” for ongoing management. In the old days everything was
done with a big commission upfront, but some disreputable advisors
made the big sale and neglected to stay in contact with the
client, which is not how financial planning is supposed to work.
The trailer fee was created to punish an advisor who doesn’t
provide service or gives poor advice to a client who can vote
with their wallets (go elsewhere), and this will affect the
advisor in the pocketbook.
Most financial advisors attempt to see clients once or twice
a year to review their portfolios and make any changes necessary
due to changes in the client’s life or fundamental changes in
Stocks should be traded only if the broker or advisor can provide
justification as to why the client would be better off making
the trade and can back up his or her arguments with facts and
A DSC mutual fund that is almost fee-free or is already fee-free
should never be moved back to a DSC fund, because the advisor
would then be getting paid twice on the same money. That’s not
fair to Mr. Client. If you have had this done to you, or have
been asked to do this, first call your advisor’s boss and then
make a complaint with a regulatory board or securities commission.
These are the Mutual Fund Dealers Association (MFDA) for mutual
funds, the Investment Industry Regulatory Association of Canada
(IIROC) for stocks, or your provincial securities regulator.
My personal belief is that the DSC option should be used very
sparingly. Advisors new to the business might use it in the
early years to help get their practice off the ground, but only
if the fund first meets the client’s needs. But I have heard
of veteran advisors who earn over $300,000 per year and still
use the DSC pricing option that can lock a client into a fund
company for six or seven years. The DSC option takes away clients’
flexibility, so how can that help the client? My advice is this:
If your advisor recommends rolling a maturing DSC fund over
into another DSC fund, find another advisor.
Always buy no-load funds (that is, zero front-end commission),
so you can always redeem or switch with no fees or worries.
Your advisor will earn money for managing your account, but
won’t receive a big commission on the fund purchase plus fees
for managing your account.
There is a low-load fund purchase option that locks you into
the fund company for two to four years. Your advisor earns less
commission for a low-load fund (usually 2% compared with 5%
for DSC fund), but it’s still best to avoid.
Be very leery of using leverage (borrowing to invest).This
can be used in limited circumstances, but this strategy has
hurt many investors who don’t get the complete picture of the
risks involved. If your advisor recommends a leveraging strategy
to you, listen to see if he or she mentions the severe impact
that down markets or corrections will have on a leveraged investment.
But if all your advisor shows you is a graph of a steady 7%
gain every year for a decade, run away quickly, because markets
don’t ever do this, let alone for 10 years.
Leverage is a long-term strategy for those who know precisely
what they’re getting into. Consider leverage as a strategy only
if you first maximize your RRSPs and TFSA every year, don’t
owe too much on your mortgage, and have a job where downsizing
the workforce isn’t easy to do (nurses, teachers, firefighters,
doctors, police officers, to name a few of the “safer” occupations).
You can write off the interest servicing costs of your debt
for tax purposes, which is a benefit, I suppose, in the same
way you can use capital losses to offset capital gains – but
that’s not enough of a compelling reason to use an aggressive
strategy like leverage.
Remember that although leverage can build assets quickly, it
can destroy assets just as fast. If the value of a leveraged
asset drops, you could be in the unfortunate situation of paying
off a loan on an asset you no longer want, and that may in fact
be worth less than your loan. In addition, you can spend a lot
of time in the hole, paying interest on your debt as you wait
for the value of your asset to recover. And it’s a lot tougher
to climb out of a hole than it is to dig it. A $40 stock that
drops to $20 has lost 50% of its value. But just to get back
to its original $40 value, that $20 stock will have to gain
Living by the rules
Most advisors live by the rules – not only because it’s the
right thing to do, but also because it’s good for business.
We get into the business to help our clients reach their financial
goals. We aim to fulfill our obligations with integrity and
good faith; to know and understand the financial circumstances
of our clients and to serve them by meeting their needs; to
make suggestions for change in a personal financial program
only in the client’s best interests; and so on. I know of no
other way to gain and keep clients through the years.
So if you ever think a strategy is unsound or too risky, don’t
be afraid to check it out with a reputable and knowledgeable
source for a second opinion. After all, it’s your money, and
your financial future.
Generic Mutual Fund Disclaimer
Commissions, trailing commissions, management fees and expenses
all may be associated with mutual fund investments. Please read
the simplified prospectus before investing. Mutual funds are
not guaranteed and are not covered by the Canada Deposit Insurance
Corporation or by any other government deposit insurer. There
can be no assurances that the fund will be able to maintain
its net asset value per security at a constant amount or that
the full amount of your investment in the fund will be returned
to you. Fund values change frequently and past performance may
not be repeated.
Personal Opinions & Recommendations Disclaimer
The foregoing is for general information purposes only and
is the opinion of the writer. This information is not intended
to provide specific personalized advice including, without limitation,
investment, financial, legal, accounting or tax advice. However,
please call the author to discuss your particular circumstances.