Can we get some service here?

I recently got a call from a fellow journalist—I’ll call her Natalie—who wanted a second opinion on her investments. Natalie had been happy with her previous adviser, but he’d retired and passed her account along to a colleague. She wasn’t pleased with the changes this new adviser had made in her RRSP—and with good reason.

We’ll get to the gory details in a moment, but first let me explain why I didn’t suggest that she simply build her own portfolio of index funds. I used to assume that the first step in becoming a Couch Potato was to fire your adviser, but I’ve changed my tune over the years. Many investors can do just fine on their own, as long as they learn the basics of financial planning and have the discipline to ride out the rough patches. Problem is, that’s more difficult than it sounds, and I’ve come to realize that most investors would do better with professional advice.

Besides, Natalie has no interest in being a DIY investor. “I’m not going to manage a $100,000 portfolio on my own,” she told me bluntly. What’s more, she has little confidence in passive investing. “The idea that I’ll just put money in the whole market and only look at it once a year—I’m not sure that’s right for me.”

I’ve spilled a lot of ink trying to convince people like Natalie that index funds offer the best chance of long-term investing success. But the whole “index funds versus active management” debate often misses the most glaring problem with the financial services industry in this country. The big issue here is not that Natalie is using actively managed mutual funds, or even that she is paying too much. When the mutual fund industry’s spokespeople defend high fees, they point out that part of that money pays for ongoing advice. True enough, but as Natalie’s situation demonstrates, that advice is often terrible. Here’s what I mean:

There’s no planning. Natalie is 42 years old and plans to retire in 20 to 25 years. I asked her how much money she thought she needed in retirement, and what rate of return she needed to get there, based on her current savings. She didn’t know, because her adviser had not created a financial plan for her. For him, “advice” meant picking mutual funds and not much else.

Imagine a doctor prescribing medication without a diagnosis—and then collecting commissions from the drug companies. Building a portfolio without a plan makes just as much sense.

The portfolio is poorly designed. Natalie’s RRSP includes 10 mutual funds. There is no reason why a portfolio of $100,000 needs that many, especially since many of her funds have redundant holdings. I asked Natalie what her overall asset mix was, and she thought it was 50% stocks and 50% bonds. (This should appear on her statements, but it doesn’t.) It took me over an hour with a spreadsheet to figure out that the actual mix was 64% stocks, just 19% bonds, and 17% cash.

Choosing an appropriate asset allocation is one of the most important services a good adviser will provide. Your mix of equities and fixed income is hugely important to your risk management and your expected long-term returns. Yet Natalie’s adviser just picked a handful of hot performers, threw them in a blender, and called it a portfolio.

He’s gambling with her money. Natalie describes herself as “very conservative” and says she endured the dot-com meltdown and the 2008 financial crisis because her former adviser had her in a low-risk portfolio. However, when she moved to the new adviser, the first thing he did was sell all her bonds, as well as three well-diversified equity ETFs. Then he put 20% of her money in two highly speculative small-cap stocks that have since lost almost half their value. This is gambling, not investing. How such stocks could ever be considered suitable for a conservative investor’s RRSP is impossible to imagine.

A professional adviser will create an Investment Policy Statement (IPS) that sets the ground rules. One of those rules should be: “The portfolio will avoid all speculative stocks, such as junior mining companies.”

She’s locked in. The overall fee (MER) on Natalie’s mutual funds is 2.31%, which is far more than anyone needs to pay for their investments. Worse, her new adviser made sure that all her mutual funds had deferred sales charges (DSCs), which means Natalie must hold them for at least six years or face hefty redemption fees. She would love to fire her adviser tomorrow, but if she does, she’ll pay over $3,000 in DSCs to get out of the funds he chose for her.

I am the first to argue that investors who need financial advice need to be prepared to pay for it. Even fee-only advisers (who do not receive commissions) typically charge 1% to 1.5%, which is a significant cost. My point is not so much that Natalie and others like her are paying too much for financial advice: rather, they’re paying too much for bad advice.

If you’re comfortable managing your own index portfolio, I encourage you to do so. If you’re not, then a good adviser is worth the fee if she can help you achieve financial goals that you can’t reach by yourself. A bad adviser, on the other hand, does little more than turn your wealth into his own