These days it's no longer just enough to say you're looking for a "financial advisor". Rather, it's crucial to figure out what type. And while everyone knows of advisors who work on the traditional commission-based model or salaried employees at banks, less well-known are fee-only and fee-based advisors. How do Canadians decide what kind of advisor to work with?
"There are a few ways advisors can be compensated and neither is necessarily greater or wrong but important for consumers to understand the difference," says Toronto certified financial planner John De Goey , vice president and associate portfolio manager at Burgeonvest Bick Securities Limited. "You really need to know yourself and the answer isn't right or wrong but circumstantial. You need to find what works for you."
Commission based: The most common type of financial advisor out there, they get compensated by selling products like mutual funds, stocks, insurance products and GICs.
Fee-based: These advisors charge a fee for their services that's generally tied to the size of a portfolio. The fee is usually expressed as a percentage of assets. For example, a fee-based advisor might charge 1 per cent on the assets with no additional trading costs.
Fee-only: Advisors who fall in this category compare themselves to lawyers and accountants in that they charge strictly for their time; they might charge an hourly rate or a flat fee per project. They don't sell products.
Most of De Goey's practice is fee-based, but he does some commission-based and fee-only work as well. (For his fee-based work, he charges 1.4 per cent on the first $250,000 under management and 0.6 per cent on all assets above a quarter-million.)
Critics of the commission model say it creates a conflict of interest -- advisors pushing products that give them the biggest payout as opposed to those that are in the client's best interests.
"About two-thirds of all advisors work on commissions and generally don't get paid unless you buy something; the products have compensation embedded in them," De Goey says.
"Often, higher-quality products are less remunerative, so it could — and I emphasize could — cause certain advisors who are of less-than valiant moral rectitude to sell things that could pay more rather than being the most suitable for clients. You can't guarantee that, but studies show a correlation between compensation and recommendations."
If you're looking to avoid the commission trap, investors should be aware many fee-only advisors are not licensed to sell products. So while they might be best-positioned to provide unbiased financial advice, they typically don't implement someone's financial plan — a task not everyone is up to solo.
"The best fee-only advisors I know don't have a licence to sell a product," says De Goey, author of The Professional Financial Advisor III—Putting Transparency and Integrity First, which comes out in October. "Rather, they charge a fee the way a lawyer would charge to draw up a will. People need to ask how their advisor is licensed."
Then there's the perception of cost: many people would rather not pay direct fees upfront, even if the recommendations from a fee-only advisor end up being more economical in the long run than those given by a commission-based advisor.
Plus, some fee-only advisors don't take on people with small portfolios, which rules out many young investors and families.
Fee-based, fee-only advisors gaining popularity
De Goey says fee-only and fee-based models are slowly becoming more commonplace. He'd like that trend to grow and see Canada follow the example of Australia and Great Britain, which banned commissions earlier this year.
"If it were up to me, Canada would legislate commissions out of existence," De Goey says. "The questionable, shady advisors who are just sales reps would get flushed out if we got rid of commissions. ... The industry is slowly but surely morphing into a professional paradigm: you need to demonstrate value-added services and you need to use evidence-based research to support the recommendations you make …The industry is starting to put the focus on genuine planning … as opposed to just selling stuff."
Toronto certified financial planner Warren MacKenzie, president and CEO of Weigh House Investor Services, would like the Canadian financial-advisory industry move from the "suitability standard" to the fiduciary model, where advisors are required by law to put clients' interests ahead of their own or their firm's.
"People make the mistake thinking that the person they're dealing with is on their side, just like a doctor or lawyer, who have a fiduciary obligation," MacKenzie says. "With the suitability standard, if you come in and ask an advisor for Canadian stocks, he's got to give you Canadian stocks. As long as it's Canadian it qualifies, it's suitable. But it's not necessarily in your best interests.
"I hope in time it will be the fiduciary standard where the advisor has to put client's interests first," he adds. "People need to understand whether their advisor works as a fiduciary or as salesperson."
MacKenzie, whose firm also helps clients find and hire a professional to manage their portfolio, says that Canadians seeking an advisor must ask what kind of regular report they'll receive.
"You want a report that shows you your performance as a percentage compared to a benchmark," McKenzie says. "What could be more simple than showing the rate of return next to a benchmark? If you look at any reports from banks, they don't show you that. They'll show that you're a little higher or lower than last month but not the rate of return compared to a benchmark.
"It's practically impossible to manage your money wisely if you have no way of telling whether your advisor is delivering value or if he is simply an additional cost that means you will have less to spend in your retirement."