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This is a tale of a very typical interaction with a big Canadian bank financial guy (I refuse to refer to these guys as advisors, since they do very little actual advising – selling bank products is what they do) who is used to dealing with customers who unquestioningly accept his advice/direction for their investment strategy. Names have been changed for purposes of anonymity but I’m certain the bank in question is fairly obvious from the title. An older retired relative, we’ll call her Lois, asked me to review her registered investments – a RRIF (Registered Retirement Income Fund) and a TFSA (Tax Free Savings Account) – at the big bank and see if there might be a way to improve the relatively unimpressive returns they were achieving (or, more accurately, failing to achieve). This review was not very difficult since it turns out the bank had every penny of Lois registered accounts invested in a single one of its portfolio mutual funds – a balanced income fund. On the face of it, having 65% in fixed income and 35% in the equity markets makes perfect sense for a retiree who is slowly drawing down their investments in retirement. No argument with the asset allocation. However, there are a couple problems with this simplistic balanced portfolio fund approach. Well, that would be problems for Lois; not problems for the bank of course.

In theory, there is no difference between theory and reality. In reality, there is.

First problem, the MER (Management Expense Ratio) associated with this balanced income portfolio fund is 1.89%. Less than two percent isn’t so bad, right? Wrong. Over the next possibly 20+ years (given that Lois is in her early 70s), paying a management fee of nearly 2% per year will reduce her returns by about 40% – money that she may well need to live on should she reach her 90s. Certainly, she’ll need it more than the bank will. Besides which, remember that 65% of her portfolio is in fixed income – so in reality she’s paying nearly 2% for active management of only the 35% equity portion of her portfolio. Second problem, holding all of her portfolio in a single balanced fund means that the value of the account will fluctuate up and down with the gyrations of the equity markets, as indeed this fund did during the Global Financial Crisis (GFC) in 2008, dropping in value by nearly 10%. Sure, the fixed income portion of the fund will have a moderating effect on those fluctuations, but that does not means eliminating them entirely. And of course given that most of her portfolio is in a RRIF, from which she’s receiving monthly payments, anytime her portfolio value decreases she will be cashing in more units of the fund to make those payments. Admittedly, when the equity markets are up, she will be cashing in fewer units of the fund to make her payments. But making up for the losses is nearly impossible when you`re drawing down at the lower value. What is preferable to this ‘all in one’ scenario, is a structure in which the withdrawals only come from the fixed income portion of the portfolio, a concept that Daryl Diamond has called a cash wedge strategy. This cash wedge will allow the ’invested for the longer term’ equity portion to gyrate as required, with rebalancing done when the equity element exceeds its asset allocation on the high side. So our approach for the RRIF was to replicate the 65% fixed income with GICs and bond funds, then replicate the equity portions using appropriate percentages of Canadian, U.S. and International equity index funds. All of which are also offered by the big bank. Not actively offered, mind you, but available.

Another concern was that while the asset allocation of 65/35 may be suitable for the RRIF, from which regular withdrawals must be made, there is no such impetus for a high percentage of fixed income in the TFSA account, particularly given the fact that at present it constitutes a relatively low percentage of Lois’ overall portfolio. Indeed, the intent currently is to take whatever cash comes available through RRIF payments that is not required for day-to-day living, and re-shelter it in the TFSA. Since later withdrawals from the TFSA will be made entirely tax-free (unlike the taxable income from the RRIF), this investment is best focused primarily in equities with a probable higher growth rate until closer to the time that Lois foresees needing to access those funds for daily living. 100% equities for now, tapering down to a more balanced approach later, will best serve Lois for her long-term financial well-being. A simple version to start is 50% each Canadian and U.S. equity index funds. Average MER on this structure is 1% and over the long run it will outperform the balanced fund charging 1.89%.

We prepared an Investment Policy Statement for Lois, laying out the concepts and rationales for the investing approach recommended, and brought it to the big bank financial guy, who we will call Killjoy. Killjoy was not impressed. Did I mention that the bank`s income from the MER on the balanced portfolio fund, based on Lois` existing portfolio value, was in the order of $7000 per year? That’s a significant amount of income for the bank, branch and indeed the big bank financial guy, who is I am sure compensated partly based on how much he makes for the bank. Our restructured approach would have reduced that bank income (skim as I like to refer to it) to well under $1000 per year. A reduction of bank income of $6000 per year made the proposed portfolio structure a very bad idea from Killjoy’s perspective. So he set about to talk us out of the idea.

First, there were the approaches to show us how much we didn’t know. Killjoy: “Do you know what a portfolio fund is?” Us: “Yes, it’s a fund of mutual funds.” Killjoy: “But do you know how well diversified all those underlying funds makes your investment?” Us: “Yes, but no more diversified than our approach using index funds, and in fact likely less so.” Failing on this approach, Killjoy attempted to convince us there was no difference in risk between the balanced portfolio fund and our equivalent asset allocation structure of GICs, bond and equity funds. This is where I like to say “In theory, there is no difference between theory and reality. In reality, there is.” It is blatantly obvious that in the event of a major stock market dip, making regular percentage withdrawals (based on the previous years’ portfolio value) will draw down the portfolio by a greater percentage than withdrawing only from the fixed income (cash wedge) portion, and leaving the equity portion time to recovery from the market dip. The latter approach will extend the longevity of the portfolio. Killjoy refused to concede this point. As Upton Sinclair once said “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” The final volley was sheer bullying, asking what qualifications we had to manage investments, as compared to the big bank financial guy`s certifications and qualifications. Um, how about it’s Lois’ money and we care more about how to make it last and grow for her than you do? That your motivation is what’s making the most money for the bank and not the client?

Ultimately, Killjoy literally refused to restructure the account as we wished. I wanted more than anything to tell the arrogant sod that we would be moving the entire account to a discount brokerage (preferably one at a different big Canadian bank) and managing it ourselves, however two things stopped me. First, I’m probably the only family member Lois has who could undertake the DIY approach to managing her investments, and if anything happened to me, in future she’d be worse off at the mercy of any big bank trying to move her investments back to them from a discount brokerage. Lois is not computer literate, I should mention. Second, Lois has lived in the same neighbourhood and patronized the same bank and branch for over 30 years. She knows all the staff there, and is comfortable there. So why should she have to move just to be able to structure her investments as she wishes?

The compromise was we chose to deal with the big bank manager rather than Killjoy. The big bank manager initially tried many of the same arguments on us, but when it was clear that we were not only firm in our plan, but also knew what we were talking about and had in no way compromised Lois’ risk level, he acceded to the proposed structure – mostly. Exhausted from two hours of trying to explain the rationale for our restructuring, we gave in somewhat by accepting the recommendation to use a growth mutual fund for the equity portion of Lois RRIF portfolio, rather than a few separate index funds. That keeps it simpler, and at least the MER Lois is paying now is only on the management of the equity elements of her investments. This event did, however, confirm my belief that the big bank financial guy`s main goal is not to make you richer than you think. It is to make the bank richer than you can imagine.

  • Michael Cloutier

    Well written. The banks prey on people being uneducated in finances so they can make the most profit. Blows me away that he refused to restructure the way you wanted.