I heard from a reader last week with a problem. Here is the summary:
• They were referred to a 'financial adviser' by a friend.
• They met with the 'financial adviser' to say they were in their late 50s and had little savings, and some pension, and wanted advice to help them retire better.
• They were then told: "Take out a $110,000 loan – I can get you that through Manulife. I will then invest that $110,000 and get you higher returns than your borrowing costs."
• So they were invested in Manulife Segregated Funds at 3.5% MER (an annual fee)!
• Today, they are concerned because their $110,000 leveraged investment is now worth $94,000, and they are paying interest.
• The segregated funds have a 75 per cent guarantee.
When I hear stories like this, I want to scream. To me, this 'adviser' showed some of the worst greed imaginable.
This couple didn't have the means to do leveraged investing, and didn't have the ability to even fully deduct their borrowing costs.
If they want to get out, they essentially can't. When they sell the funds, they will be about $20,000 away from paying off the loan. This is in part because of losses on investments, and further punishment from deferred sales charge fees for selling the funds early. Guess what. They don't have $20,000 available without tapping into their RSPs. These people are stuck.
Think of what has to happen for these people to come out ahead:
Borrowing costs of 3.5 per cent today (the rate could change, and will likely go higher in the next few years at least). Investment costs of 3.5 per cent. Even if you say their borrowing costs are tax deductible, in this case, it brings it down to 2.5 per cent. They still need to make over 6 per cent just to break even.
The 'adviser' makes money on the loan, and makes a lot of money on the segregated fund sale.
Of course, the overly simple, but likely proper advice for this couple in their situation would be to try to work longer, save more.
The 'adviser', who isn't even licensed to sell investments other than segregated funds, saw a new prospect with little to invest, and still managed to make a good sale.
How do we all prevent this type of situation from happening? Here are three recommendations:
1) Ban the leveraged loan programs on non-registered investments that several fund companies make available – unless the investment product has a fee under 2 per cent. In the case above, a 4 per cent investment fee is ridiculous, but is even worse when someone is adding interest costs on top. While I am generally not a fan of the RSP loan programs, at least if the client is in a high-income bracket, the tax 'refund' can make the strategy make sense.
A leveraged loan program tied to the purchase of non-registered funds with a high fee is almost always a poor strategy for a client.
2) Have organizations like the Investor Education Fund that is funded by the Ontario Securities Commission, focus on three or four common financial mistakes that can hurt them. The Investor Education Fund does good work, and can really help in this area. The more education that is out there, the fewer Canadians will say yes to a strategy such as this.
3) Hurt the product marketer and seller where it counts. The products and selling strategy that was used by this 'adviser' are all legal. Today, as it stands, the 'adviser' still gets paid, and Manulife makes good money. This wasn't a case of poor markets. This was a case of greed. The strategy using these investment products simply doesn't hold water given the cost of investments that were being used. There needs to be a way for a client to receive compensation from the product provider and the 'adviser'. In this case, the regulator of the 'adviser' is the Financial Services Commission of Ontario. I am not sure if there is a way for the regulator to help manage this process, but they certainly have the ability to fine or punish the parties involved if they deem it appropriate – and possibly make restitution to the client. At the moment, I am not sure what other organization would be able to hit the product marketer and seller in the pocket book.
I guess when all is said and done, these situations simply make everyone in the financial advice business look bad. Because of that, I believe that people within the industry have a responsibility to try and prevent this type of greed and terrible advice. If we speak up about it and try to change it, we can hopefully significantly decrease cases such as this.
Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He has an MBA from the Schulich School of Business and is a certified financial planner. He was vice-president of business strategy at a major Canadian brokerage firm.
Follow Ted on his blog at The Canadian Financial Planner.
Ted Rechtshaffen