Professional advice is invaluable for long-term investors saving for retirement. Background knowledge and proven strategies that could seem insignificant at the start can mean the difference between a lifetime of financial struggle, and spending your twilight years in comfort and security.
But it’s important to understand that profit is the primary goal for banks and investment firms that dispense advice – and that advice is sometimes in their best interest and not yours.
Here are three of the worst pieces of advice from the finance industry.
1. It’s always the right time to invest
All the major Canadian banks have investment arms which operate at what is termed “arm’s length.” Banks generate revenue by lending money through mortgages, consumer and student loans, and bank-sponsored credit cards. Their investment arms generally generate revenue through investment fees. It’s a zen moment for them when they can generate revenue through both channels from the same people, at the same time.
It’s an investment advisor’s job to lay out investment options that provide the best returns with the lowest risks. With Canadian household debt at record highs, most advisors fail to inform their clients that the best return with the lowest risk is often to simply pay down debt before investing at all.
Interest on the average consumer loan is about 10 per cent. Interest on balances for bank-sponsored credit cards like Visa and Mastercard is normally in the high teens. Any qualified advisor should know there is no investment that can guarantee returns that high, and the best advice for their client is to put investing on hold until that debt can be managed at a lower rate.
Even tax savings from investing through a registered retirement savings plan (RRSP) or tax-free savings accounts (TFSA) pale in comparison with interest savings from making debt a priority.
2. Fees have little impact on returns
Investment firms are required to disclose fees upfront. Since most Canadians invest for retirement through mutual funds, the biggest fee is calculated as a percentage of the total amount invested each year, known as the management expense ratio (MER).
A typical annual MER on an equity mutual fund is 2.5 per cent; some are higher, some are lower. In most cases, advisors are compensated by the mutual fund company through the MER.
That means the return on the fund is reduced by 2.5 per cent every year. In order for you to get a five per cent return, the fund must generate a return of 7.5 per cent. This is why most mutual funds underperform the index they track.
Over time, those fees can add up to tens of thousands of dollars that don’t generate returns by staying invested.
3. Always have cash on hand for emergencies
We often hear finance industry advocates parrot a general rule that households should have between three and six months of monthly expenses in cash for emergencies.
First, with household debt-to-income currently nearing a record $1.80 for every dollar of income, it’s unrealistic to think the average Canadian has the ability to set aside that much cash.
Second, with the household debt-to-income ratio that high, household debt is an emergency. That emergency money would be better spent paying down interest-generating debt than sitting in a bank account earning zero interest.
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Having debt eliminated, or at least under control, leaves households in a better position to deal with emergencies – even if it means borrowing through a line of credit only when they occur.
Ideally, households will have built up enough equity to borrow from a secured line of credit, such as a home equity line (HELOC), at the best going rate.
In addition, those thousands of dollars sitting idly in a bank account year after year could also be better spent invested in a RRSP or TFSA and compounding. The potential loss is staggering.
This advice is especially disingenuous when you consider banks make the bulk of their profits on the gap between borrowing at low rates and lending at high rates. It’s possible your money generating zero interest is being lent out to someone who can’t pay the balance on his credit card at 19 per cent.
Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email firstname.lastname@example.org.