I often hear stories from investors who
have asked their financial advisor for
low-cost index funds and have been met
with some sort of rebuttal those are
only stories but we do know that as at
the end of 2016 only eleven point three
percent of Canadian investment fund
assets were invested in low-cost index
funds based on the data it is probably
fair to say that the majority of
financial advisors are not recommending
index funds to their clients I think
that most financial advisors have good
intentions but there is clear academic
and empirical evidence that the actively
managed funds that they often recommend
are not in the best interest of their
clients the evidence is clear and your
financial advisor is probably a good
person so why are they still selling
actively managed mutual funds I'm Ben
Felix associate portfolio manager at PWL
capital in this episode of common sense
investing I'm going to tell you why most
financial advisors are not recommending
index funds
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I think there are four main reasons that
financial advisors are not excited about
recommending index funds to their
clients Commission's career risk their
value proposition and a lack of
knowledge let's talk about Commission's
the reality for Canadian investors is
that the majority of financial advisors
in Canada operate by selling mutual
funds that pay them commissions
financial advice in Canada is generally
held to a suitability standard in other
words as long as the advice is suitable
for the client it does not have to be in
their best interest this causes a
problem for investors where their
financial adviser can legally sell them
products that generate large commissions
for the advisor at the expense of the
client low-cost index funds do not pay
these types of commissions this isn't
news to anyone this conflict of interest
is becoming increasingly well understood
by investors which is causing an
increasing number of financial advisors
and their firms to offer fee based
services on a fee based model the client
pays the advisor directly removing the
Commission incentive for recommending
high fee products removing Commission's
may seem like an easy fix but
Commission's are not the only reason
that most financial advisors don't
recommend index funds to their clients
think about a financial advisor who's
been in business for 10 or 20 years
chances are that they've been selling
actively managed mutual funds or picking
stocks for their clients for the
duration of their career investment fads
have come and gone but they've settled
on some strategy that their clients are
comfortable with it is highly unlikely
that that strategy has been investing in
low-cost index funds it would be
extremely challenging for any advisor to
change their tone and start recommending
low-cost index funds doing this would
effectively mean telling their clients
that they have been wrong about their
approach to investing and that they need
to make a drastic change it would be an
admission that all of their market
predicting and manager selection has not
been adding value that brings us to the
next challenge for advisors what is the
value of a financial advisor for many
years it has been selecting mutual funds
or individual stocks a meeting with a
client might consist of reviewing the
performance of the stocks or funds in
their account and making decisions about
selling those funds to invest in
something else any advisor that operates
this way would have an obvious challenge
and recommend
index funds all of a sudden they're no
longer able to add any value how would
they keep their clients it's pretty
obvious that there would be some major
challenges for an advisor that decided
to start recommending index funds to
their clients making that decision would
require significant conviction it is
accepted as truth in the academic
community that index funds are the most
sensible investment for most investors
but getting that point of understanding
does require some time spent absorbing
the body of evidence that supports
investing in index funds if an advisor
has a successful business without index
funds they have little motivation to
invest that time it doesn't help that
actively managed mutual fund companies
offer material designed to convince
advisors and their clients that actively
managed funds are still the best option
it's like doctors being told by the
tobacco company is that cigarettes are
healthy advisors have little motivation
to gain an understanding of the research
and they're being fed anti evidence by
the big fund companies I've just told
you four reasons why financial advisors
are unlikely to recommend index funds
most of these advisors will offer you
reasons that index funds are scary an
advisor might say that index funds have
no chance of meeting the market or that
they will be disastrous in a down market
while these reasons to avoid index funds
may sound good in a sales pitch they
refuted by the data on average active
funds lag the performance of index funds
including during down markets the fact
is that investing in actively managed
strategies whether in a mutual fund or
through stock picking increases your
fees transaction costs and risks when
you make an active decision to be
different from the market you are
betting that your active manager is
going to be able to outperform by
selecting the right stocks and bonds at
the right time statistically there's a
very small chance that they will be able
to do so the result for you is higher
expenses and less tax efficiency in
exchange for a relatively small chance
at better performance and a large chance
of underperformance compared to the
market if your financial advisor is
investing your money and actively manage
strategies it is likely that they are
either being influenced by commissions
or that they are not aware of the
evidence supporting index investing if
they are not influenced by commissions
and are aware of the evidence then they
are intentionally taking on an active
risk in your portfolio active risk has a
very low probability of
working out in your favor do you want to
be taking on extra risk and return for a
small chance of beating the market if
you do then your advisor might be a
great fit for you with the low
probability of consistently achieving
market meeting returns it is far more
sensible for most people to simply
capture the returns of the market using
low-cost index funds if your financial
advisor disagrees you might be better
off elsewhere my name is Ben Felix of
pwl capital and this is common sense
investing I'll be talking about a lot
more common sense investing topics in
this series so subscribe and click the
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I want these videos to help you make
smarter investment decisions so feel
free to send me any topics that you
would like me to cover
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