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Investing - The Basics

What's it all about? Nowadays it seems almost everyone is investing in RRSPs, mutual funds, shares, or other form of investment rather than GICs or bonds. Some are investing with brokers, some with financial advisors, some with the banks, some with mutual fund salespeople, some with insurance salesmen, and the list goes on.

Some investors have found that their investments have not done so well and have decided to use discount brokers and make their own decisions. That is fine for those who have the knowledge and the time. But it could be risky for anyone who lacks the knowledge to determine the amount of risk involved with a particular investment.

It is important that every investor take these first two steps before investing or continuing to invest.

BE AWARE that many fraudsters are not registered and do not work for firms with large resources. So when things do go wrong there is often no recourse to obtain restitution. If however your Adviser/Advisor is registered and with a large firm there are resources that should enable you to get restitution in the event of wrongdoing and successful dispute resolution.

FIRST STEP – CHECK YOUR ADVISER/ADVISOR’S REGISTRATION

The most important step for all investors new and old is to first understand the investment industry registration classifications. The following is a link to the Canadian Securities Administration (CSA) website document Understanding Registration which indicates the classifications for registrants.

BE AWARE that most “Advisors” are registered as "Dealing Representative – A sales person". There is no category of “Financial Advisor” with the CSA. If your “Advisor” is not registered with the CSA you should check with your local Securities Administrator. A list with contact details is provided on our “Regulators” page.

BE AWARE that Self Regulatory Organizations SROs do use the word “Advisor”. However it is the Securities Administrators who are responsible for securities regulation and their registration classifications are in accordance with the Securities Acts.

The IIROC information is less than clear but is reproduced here for reference:

Financial certifications and designations are not the same as a registration or license.  An advisor may use various financial certifications and designations whether or not he or she is registered or licensed with a regulatory body, like IIROC. 

If an advisor represents that she or he has special expertise - a certification or a financial designation - you should make sure you understand what the certificate or designation means and what the advisor did to obtain it. If an advisor tells you that he or she has a certain designation or certification, ask questions. Do not rely solely on a financial certification or designation to determine whether an advisor can provide the type of investment services or products you need.

To assist in your background research, IIROC’s Glossary of Financial Certifications, current as of April 1, 2014, (Note: This is a list of 49 certifications) provides basic information about certificates and designations commonly used within the Canadian financial services industry. IIROC does NOT grant, approve, endorse or rank any financial professional or advisor titles.

IIROC’s glossary includes information about whether the issuing organization has an investor complaint process. However, if you are dealing with an advisor who has been licensed by IIROC, we encourage you to contact IIROC. See Making a Complaint to learn more.   

Certain key statements have been highlighted for your reference.

SECOND STEP – CHECK IF YOUR ADVISER HAS BEEN DISCIPLINED

Visit the CSA website and check their Disciplined Persons webpage that provides access to disciplines of all persons registered across Canada. Simply click on the first letter of the last name of your Adviser/Advisor to see an alphabetical list of persons disciplined.

AFTER CHECKING YOUR REPRESENTATIVE’S QUALIFICATIONS AND HISTORY, IT’S TIME TO INVEST

All investors should demand a monthly report that shows the annualized rate of return for their investments. This rate of return should be compared to a benchmark. We suggest that if your investments are not providing a rate of return above that of Canada savings bonds you need to get a second opinion. If you invest in funds or other investment products with risk and your rate of return is not comparable to that of the Toronto Stock Exchange index then you should get a second opinion.

There is a move towards paying for investment advice similar to the way you pay for other services. This avoids the conflict of interest where your "financial advisor" is paid by commission. Insurance salesmen and mutual fund salesmen are particularly prone to being influenced by commission as the rewards appear to be greater for those products least suitable for investors. There is also the temptation for those rewarded by commission to churn accounts to increase their earnings. In addition many firms have leverage programs that elevate the risk for investors but increases the Assets Under Management (AUM) upon which the firm and salesmen generate fees. A particularly egregious scheme is where the firms arrange loans directly at a co-operating financial institution on behalf of the investor.

At SIPA we do not give investment advice. However, we believe it is important for all investors to gain sufficient knowledge of investing so they can determine how they should be investing and in what types of products. Investors have different needs and one approach is not the best for everyone. Your investment strategy should be based on your individual needs.

About "Financial Advisors"

Larry Elford in Alberta has produced an excellent video on the Advisor/Adviser name game. View it >>

Investors should be aware that registered representatives until recently were registered by the regulators as sales representatives as they were responsible for selling investment products such as mutual funds or other structured products to consumer/investors. The industry follows a practice of providing titles to instill confidence in the consumer/investor that they are getting sound financial advice.

In many cases these so-called "Financial Advisors" may be approved to sell only mutual funds while an expert who provides investing advice would normally advise diversification amongst various investment vehicles.

Many consumer/investors have adopted a do-it-yourself approach and invest bonds, shares and Exchange Traded Funds (ETF) to provide diversification. Others are opting to hire Financial Advisers, to provide financial advice only, who are paid by the hour and do not receive commissions. This approach eliminates the possibility of commission influenced advice.

Most consumer/investors may need a financial advice. The first step is to check whether the representative is registered and what investment products he is qualified to sell. You should also check whether they have been disciplined and this can be done on the Canadian Securities Administrators (CSA) website that now provides an alphabetical list of disciplined persons. The CSA website provides a link to the Ontario Securities Commission (OSC) website to check on Ontario registrants.

Common elements when investors lose

Investors need to be aware that many investors have lost all of their savings when they trusted blindly in their advisor. It may have been an insurance salesman, a mutual fund salesperson, a broker with a large bank owned full service broker, or any other financial advisor.

The common elements of all those who have lost a significant amount of their savings are:

  • They trusted their advisor (as everyone must)
  • Their investments were leveraged (margin, bank loans or mortgage)
  • Their investments were concentrated in one type of product ... they lacked diversification.

How can investors avoid losing?

There is always some risk to investing. Fixed income investments may have a guarantee, but the guarantee is only as good as the institution backing the guarantee. Most investors will have some investments in equities, equity based mutual funds or indexes in the hope that returns will be higher. That may generally be true in the long term but there can be short term volatility.

On the basis of the experience of those who have lost all or a significant portion of their savings it would seem that to protect yourself you must:

  • Check with the regulators that your broker/advisor is properly qualified and registered and what type of securities he can sell.
  • Check with the regulators that the company he represents is properly registered and insured to protect you in the event of bankruptcy or fraud.
  • Ensure that your investments are diversified so that you have an appropriate asset mix, and possibly a mixture of fixed income and growth. This will vary depending upon your age, income, financial resources, and the purpose for your investments. Most small investors will need help to prepare an appropriate investment strategy.
  • Be wary of leveraged investments. Many companies promote leveraged investments by offering margin or bank loans. They may encourage you to mortgage your home to invest. You must remember that these loans must be repaid even if the investment is a total loss. Many investors have lost everything when they had leveraged investments.
  • Be wary of Limited Partnerships or other forms of investment that you do not fully understand. Many of these "projects" do not work out as described. Many investors have experienced significant loss because they concentrated a large part of their assets in this type of investment.
  • Remember that investing is long term, and gambling is short term. If you are looking for a quick return, you are gambling. 

Selecting a broker/advisor

While there are good and bad broker/advisors in most investment dealers, mutual fund companies and dealers, and insurance companies, many of the firms have operating philosophies that emphasize profit at the expense of their clients.

While you should check with the regulators about your broker/advisor, experience has shown that many broker/advisors breach the rules for several years before they are disciplined. The regulators will not reveal if there are complaints and only release details of disciplines.

One of the best ways to select your broker/advisor is through the recommendation of a trusted friend. However, even this may not be foolproof. Your friend may have different objectives and accept a different level of risk. His broker may trade aggressively for all his clients and this may not be appropriate for you. There is no substitute for becoming more aware and increasing your knowledge of investing. It is your money, so you must learn as much as you can to minimize the risk of losing it.

The investment industry generally operates on the basis of the sellers of financial products being paid a commission whenever you buy or sell a security. When you buy a mutual fund or segregated fund you may not pay a commission directly but the salesperson receives a sales commission from the fund company. This is the reason for a deferred sales charge so this commission can be recovered by the fund company should you decide to sell early. In addition the salesman receives annual trailer fees as long as you hold the fund.

Since the sellers are generally commission driven and some managers push the salespeople to generate more commission there is a natural impulsion to employ strategies that maximize commissions. This can result in churning of accounts, excessive trading or using leverage. Mutual fund sellers will often employ the devious tactic of selling 10% of your mutual funds each year and then reinvesting in other funds to generate new commissions which are greater than the trailer fees they would receive if you held your funds. This rollover tactic is offered as a benefit to investors, but in reality it is of benefit only to the industry. It is another example of the illusions created by the industry.

Why do investors lose?

The investment industry is largely commission motivated. With the amount of money involved and the ease with which broker/advisors are able to use other peoples money to generate commissions, the temptation is great for broker/advisors to breach the rules. 

Although a regulatory system is in place and the rules appear to provide appropriate protection, the sad reality is the rules are often not followed. The penalties for beaching the rules are generally not sufficient to discourage practices that are well established in the industry.

The regulators are not empowered to order restitution and seldom order disgorgement of profit. The biggest fines seem to be imposed when they can not be enforced, or when a broker/advisor cheats his firm. Sadly, it really is "Buyer Beware" for investors when it should be a professional industry with sound morals and good ethics because they are dealing with the life savings of investors.

Financial predators abound in the industry. There are high-rollers working for major firms who take advantage of their clients as well as the small independents like Patrick Kinlin who died in jail. There are penny stock dealers who sell worthless stocks to small investors, and there are larger firms who either buy up stock and sell it to their clients, or sell their clients shares in new unproven companies which sometimes tank.

The industry feeds off investors by charging fees for trading or for holding assets. The latter as management fees or trailer fees in the case of funds. These fees are not related to how much the investor makes.

Will it ever change?

As investors learn more about how the industry operates and become empowered by the world wide web, the industry will be forced to modify its behaviour. Already we are seeing signs of change. Information is now available to the public that in the recent past could not be obtained through official channels. The regulators are now discussing openly changes that would not be aired a few years ago.

Some of the interesting things that are happening in the investment industry which should help small investors are some companies see the writing on the wall and are beginning to look at different ways of providing a service where the small investor will not have so much risk of his broker churning accounts to generate commissions.

Major brokerages are offering managed accounts at a much lower entry level than a few years ago. These operate in a similar way to mutual funds but there are no deferred sales charges or trading commissions. Your account can hold the particular shares and bonds to provide appropriate diversification. The brokerage will charge an annual fee in the order of 2% of your assets. The firms can provide a history of the performance of these managed accounts for you to review. This is a good approach for small investors to get diversification and avoids the risk of broker abuse that has caused so many investors to lose a major part of their savings.

Some firms offer a program where you can select a list of companies and invest in these on a regular basis. This method means that you buy more shares when the price is low and fewer when the price is high. In these days of volatility dollar cost averaging is not a bad idea. You will have to have some investment knowledge to select companies that are appropriate for you. One of the advantages is that you do not have the normal brokerage fees and you can enjoy diversification without a major investment in each company. It provides similar diversification advantages as pooled funds or managed accounts but with a lower level entry requirement.

Some firms have a philosophy that appears to be focused on providing service for clients. Although the brokers are rewarded by commissions on trades there are two positive aspects of their philosophy:

  • They do not believe in margin for most investors and so most of their accounts are operated as cash accounts.
  • They do not provide financing for companies the way large brokerage firms do, so there is no requirement for their brokers to be pushing their clients to buy new issues.

Also, they can sell different types of securities including bonds, mutual funds and shares to enable asset diversification.

Some registered representatives have chosen to offer services as a financial planner and offer a professional advisory service based upon a fee that is not effected by the amount of trading or choice of product. This removes the incentive to churn your account or to select products based upon commission levels rather than quality of product. This service seems particularly appropriate for those with limited investment knowledge or the desire to have someone look after their investments.

Should you monitor your account

Investors dealing with established firms may receive early warning of trouble if they monitor their account statements. However, there have been cases of advisors issuing fraudulent statements to unsuspecting investors. Most firms will provide a monthly report if requested. However some firms provide reports only on a quarterly basis unless there has been account activity.

Investors should insist upon a monthly report. You should review your report and if you do not understand it, ask questions until you do. If there are items that cause you concern, you should talk to your broker's manager. If your broker happens to be the head of the firm you should get some independent advice.

You should ask your advisor for a monthly report that shows the annualized rate of return and a comparison to established benchmarks or indices. Many firms have better reports that are available for the asking. Their philosophy appears to be to provide the minimum amount of information to clients unless they request more. Sophisticated or large investors will demand appropriate reporting or will move their accounts to firms that will provide adequate reporting.

As a minimum, you should compare the value of your account on a monthly basis. Most firms provide a comparison between the value this month and the value last month. If you have not taken money out or put money in, the value of your account will probably be up or down in accordance with the general market direction. All investors should demand a monthly report that shows the annualized rate of return.

You need to be aware of the general market trend. If your account value is going down when the market is going up you should make inquiries as to why this is happening, and also should seek independent advice.

It is much easier to prevent major loss than to effect recovery. Remember, it is your money and your future.