Who Needs Financial Advice and Why
Regulators around the world are looking at measures to ensure that investors understand the costs of investing and are receiving value for their money. As different approaches are tested, it is becoming clear that a one-size-fits-all approach to fee regulation can lead to unintended consequences that may disproportionately impact some segments of consumers in particular, more modest investors and those just starting on the savings path.
This backgrounder provides data on the household assets of Canadian investors and the difference that access to advice can make in their long-term savings.
Who is the modest Canadian investor?
According to research conducted by Investor Economics and Pollara, Canada's typical modest investor:
• Belongs to the 79% of Canadian households with less than $100,000 in investible (non-real estate) assets,1
• Is among the 7.9 million households in Canada that owns investments through the MFDA channel,
• Is likely to have started investing with less than $25,000,2
• Holds his/her savings in a combination of investment funds, GICs, and deposit accounts,3
• Is likely to have purchased mutual funds through an advisor. In fact, eight out of ten modest investors purchased their funds through an advisor.4
Does financial advice matter for the modest investor?
• Compared with investors who go it alone, investors who use financial advisors see their savings grow by 2.9 times more after 7 years and 3.9 times more if they continue to use advisor for 15 years.5
• In addition to helping investors choose the right products to meet their goals, advisors serve as financial coaches, helping investors to develop disciplined savings habits and avoid common investor behavioural pitfalls.
• 90% of Canadian mutual fund holders invest through an advisor; 88% of mutual fund investors agree they get better returns because of advice.6
• Charts that purport to show the negative impact of advice fees on long-term returns erroneously assume that unadvised investors will contribute to their savings at the same rate as those with an advisor, ignoring behavioural research that consistently shows most individuals who go it alone are less disciplined in their savings habits and more prone to behavioural errors.
• Other comparisons often fail to note that mutual fund fees often include an advisor fee that must be paid separately when investing in products such as ETFs through an advisor.
• Research has also found that, over a five-year period, households who kept their advisor saw a greater increase in their asset values than households who dropped their advisor during the same period.7
Is there an advice-gap and why does it matter?
• An advice gap can be measured in two ways:
i) The ability of individuals who want financial advice to find it at a price they are willing to pay, or
ii) The difference between all those who would benefit from financial advice and those who are actually working with a financial advisor.
• By the first measure, there is no evidence of an advice gap in Canada today. The availability of various fees payment options, especially embedded commissions, enable Canadians of modest means to access affordable advice proportionate to their assets.
• The second measure can only be solved through education of the benefits of advice and by ensuring that the industry can continue to provide those who seek advice with the service they want at a price they are prepared to pay.
• Investor Economics estimates the average embedded commission (trailer) to be 0.78% or $780 per year for the modest investor with $100,000.
• Compare this to fee-based accounts in the US where the investor needs a minimum of US$100,000 on which they will be charged 1.3% or US$1,300 annually. With compounding, on an annual return of 5%, the difference between 0.78 and 1.3 will add up to more than US$7,000 after 10 years.
• The result is that modest investors in Canada pay less in fees than modest investors in the US for comparable funds.
• MFDA research finds that typical front-end load domestic equity funds may pay a 1% trailing commission and a front-end load domestic fixed income fund may pay a 0.65% trailing commission. For modest investors, this compares to fee-based channels, where rates generally begin at 1.5%.8
• UK regulators have admitted that reforms instituted there, including a ban on embedded commissions, have created an advice gap for more modest investors. Firms have increased their account minimums and new account openings among modest investors (£30K £100K) are down. The government is now introducing a number of remedial measures that include letting people withdraw up to £1000 from their pension savings without tax consequences in order to pay for financial advice.
Canada and the World
Regulators have suggested that Canada is lagging the rest of the world in banning embedded commissions. The facts indicate otherwise.
• Banning embedded commissions has been evaluated by securities regulators in many jurisdictions. Only four (Australia, the Netherlands, the UK and South Africa) have opted to proceed.
• Securities regulators and governments in 10 other countries, including Sweden, Hong Kong, Germany, New Zealand, and Singapore, have examined this option and explicitly ruled out a total ban on embedded commissions because of concerns that it will create a potential advice gap.
• Europe, through MiFID II, has proposed to prohibit independent advisors from accepting commissions; however, the independent advice channel is one of the smallest channels in the European funds industry, representing just 11% of assets. The vast majority of fund sales are made through banks, where the MiFID II prohibition does not apply.
• With respect to embedded commissions, only 13% of total worldwide mutual fund assets of US$39.4 trillion are covered, or slated to be covered, by a ban.
The information in this backgrounder is drawn from Advice and the Modest Investor: A Canadian Perspective.
The Investment Funds Institute of Canada is the voice of Canada's investment funds industry. IFIC brings together 150 organizations, including fund managers, distributors and industry service organizations, to foster a strong, stable investment sector where investors can realize their financial goals. By connecting Canada's savers to Canada's economy, our industry contributes significantly to Canadian economic growth and job creation. The organization is proud to have served Canada's investment funds industry and its investors for more than 50 years.