Investing At Ground Zero Calculating Your MM Factor
When I talk with clients about financial planning, one of the more difficult areas is money management. Is your money manager doing a good job? If you are looking for a new one, how will you select the right one? They often reply, yes, we have been with the same person a long time and really don’t want to change! To be clear, we are talking money management here–not other aspects of financial planning such as income tax, estate planning or insurance. Many financial institutions claim all of this to be in their territory but sometimes that’s a stretch.
What You First Look At
To me, rating a money manager depends on three things–your stage in life, your personal advisor and the policies of the advisory firm – and all are important. Assuming that you really can articulate your personal situation (and that’s a whole other topic), you need to look at the advisory firm’s policies and your fit with the advisor who will be guiding your investments.
How Much Do You Have To Invest
The availability of an advisory firm depends on the money you have to invest. I rank advisory firms into six categories (my take on this) and all have their limits on minimum portfolio size as shown below:
• Banks
Private investment counselling $1,000,000
Wealth advisor 500,000
Branch banking 500
• Independent portfolio managers $1,000,000
• Wealth advisor $200,000
• Investment counselling firms $400,000
The banks have three levels of service. You may qualify for wealth advisor service with about $500,000 in investments. Private investment counselling is for the significantly wealthy and is staffed by lawyers, accountants and other specialists. Banks are protected from intrusion by foreign acquirers so their investment management services enjoy significant protection. Banks squeeze out competition by only offering proprietary funds at the branch level.
The minimum portfolio sizes shown above vary from firm to firm. Firms are usually flexible on this depending on what you bring to them and how you fit into their internal guidelines. When you are shopping for an advisor, you will find out very quickly who lets you in and who doesn’t. If you don’t fit, they may shift you to another tier in their organization--if one exists. This article does not deal with self-investing but even there, fund companies may require a minimum investment.
Services Can Vary
Firms generally fall into one of the categories shown above but some are hybrids. Wealth advisors usually offer services beyond money management and may use mutual funds for smaller portfolios to get needed diversity. Investment counselling firms tend to be independent and not part of a larger group, and they stick to money management. Independent portfolio managers offer investment services much like the old stockbrokers once did but today they have a better skill set than they did in years gone by. They usually charge on a fee basis rather than on a transaction basis.
Discussions around the water cooler can slam the banks, mutual fund companies or even the firm you are with. Of course, there are firms that perform well and those that do not. Maybe it’s a personality clash. Maybe you didn’t do your homework to check for a good match. If you had, you might have made a different choice. There’s lots of blame to go around.
The Mm Factor
So how do you rate money managers? I have been trying to figure that out for years so I finally designed a scorecard to calculate what I call the MM (Money Manager) factor. It allows you to rate advisors on a points basis and compare their scores. It should help you decide just how suited each is for your particular needs. It should also help in comparison shopping–regardless of whether you are super wealthy or have a modest portfolio.
I divided the scorecard into two parts–Part A deals with the positive aspects and Part B deals with the things you should avoid. I then assign a score to each rating (a few higher than others) so at the end you can count up the points and get a total score. You could come up with a negative total where you didn’t find much positive and a whole lot of negatives.
Here is the chart (my invention) to calculate the MM factor:
| A - POSITIVE ONLY RATINGS | Maximum Score |
Advisor Rating
|
| 1) DETAILED ANNUAL REPORTING OF PORTFOLIO RETURNS | 1.5 | ____ |
| 2) QUALIFICATIONS AND EXPERIENCE OF YOUR PERSONAL ADVISOR | 1.5 | ____ |
| 3) ANNUAL REPORTING OF FEES CHARGED | 1.0 | ____ |
| 4) CUSTOmiZED PORTFOLIO (BASED ON YOUR AGE) | 1.0 | ____ |
| 5) FREQUENCY OF ADVISOR CONTACT (QUARTERLY, ANNUALLY, NEVER) | 1.0 | ____ |
| 6) TAX DEDUCTIBILITY OF FEES (AS OPPOSED TO COMMISSIONS) | 1.0 | ____ |
| 7) ADVISOR FOSTERS TEAMWORK WITH YOUR OTHER PROFESSIONALS | 1.0 | ____ |
| 8) FEE RATE REDUCED WITH SIZE OF THE PORTFOLIO | 1.0 | ____ |
| 9) INVESTMENT ADVICE CONSIDERS TAX CONSEQUENCES | 1.0 | ____ |
| TOTAL POSITIVE SCORE | 10.0 | ____ |
| B - NEGATIVE ONLY RATINGS | Maximum Score | Advisor Rating |
| 1) LACK OF DISCLOSURE OF RETURNS EACH YEAR | 1.0 | ____ |
| 2) LACK OF FEE DISCLOSURE EACH YEAR | 1.0 | ____ |
| 3) HIGH COST OF FEES | 1.0 | ____ |
| 4) NOT WORKING WITH YOUR OTHER PROFESSIONALS | 1.0 | ____ |
| 5) LARGE FEES ON SELLING SECURITIES (EG. BACK END LOADS) | 1.0 | ____ |
| 6) INABILITY TO PURCHASE NON PROPRIETARY INVESTMENTS | 1.0 | ____ |
| 7) ACTIVE CROSS SELLING OF IN HOUSE PRODUCTS | 1.0 | ____ |
| TOTAL NEGATIVE SCORE | 7.0 | ____ |
| TOTAL SCORE | ____ |
Positive Ratings
The quality and completeness of your returns (since inception, year to date, etc) is so important. Given that, in depth explanations and discussions with your advisor can follow. Sadly, this is often missing even though it is so important! The qualifications and experience of your personal advisor also get extra points. Other factors need to be rated to get the total for the positive ratings. You should ask lots of questions and assign MM ratings to every point.
Negative Ratings
Too often, it’s the negative ratings that create mistrust and kill communication with advisors. Your advisor or the firm may promise more than they can deliver. They don’t want you to talk to anyone else because you might stray. Some firms say they can help with financial planning (taxes, estate planning, etc.) but many don’t do a good job and shouldn’t go there. Financial planning is a team sport and needs many players (lawyer, accountant, tax advisor, etc) to be successful.
The cost of fees is hidden too often. Personally, I believe that fees should not exceed about 2.0% of your total portfolio and if they do they are excessive. Some investors don’t mind paying high fees for suggested higher returns but they are living in a utopian world. Time will eventually catch up to the cost of high fees. In any event, they seriously drain long-term portfolio growth.
Your Advisor And Your Comfort Zone
The scorecard is a ground zero rating and doesn’t deal with good feel and confidence that you want to develop with your advisor. That’s more subjective than the MM ratings but can kill a relationship. After some time with an advisor, you need to come away with a feeling that they really know their business, that they have an informed opinion on the portfolio they have chosen for you and they can articulate their views in a way that is understandable.
Marketing And Fiduciary Duty
It seems that the delivery of quality investment services by the wealth management industry is so often trumped by marketing. All professionals have to promote their services but fiduciary duty to clients must always come first. There was an interesting article in the December 18 edition of the Globe and Mail titled Wealth Management Industry Resists Reforms. I will share a few quotes with you from that article because they are thoughtful and revealing:
The wealth management world hasn’t experienced major reforms in nearly two decades.
Advocates of reform argue that investment advisors currently have no fiduciary obligation to their clients, and therefore are free to act like salespeople, selling products that improve their own profits through higher fees. Opponents argue that an existing, flexible framework is already in place and that there are already new rules coming from bodies such as the Investment Industry Regulatory Organization of Canada (IIROC), which is implementing rules that force advisers to disclose to clients the exact amount they pay in fees each year.
While Canada debates reforms, the United Kingdom and Australia are enacting their own, including banning sales commissions for investment advisers.
There is also pushback from the industry on changes to mutual fund fees, including the elimination of trailer fees, which typically pay advisers 1 per cent a year for keeping their clients in a certain fund.
Investors worry about the service they are getting for the many reasons mentioned above. In the October 2013 edition of the Canadian MoneySaver, Ken Kivenko wrote an excellent article critiquing advisor shortfalls. His comments fit nicely into the MM scorecard and I recommend it for reading.
I like the scorecard and it may change as I get reaction from my clients. But for now, it’s a start. It’s better than cursing an advisor when you never gave them an evaluation in the first place.
Ed Arbuckle CPA, FCA, TEP, Personal Wealth Strategies - Fee based family wealth planners and personal tax advisors, 205 - 30 Dupont St. E., Waterloo, Ontario
Phone: 519-884-7087