The Great No-Help Lie

"The Great No-Help Lie is that you can pick superior performing mutual funds by yourself without paying for an advisor." -- Nick Murray

Nick goes on to say that real people do not get investment returns, they get investor returns.

The "Great No-Help Lie" likely refers to the popular press whose linear, cognitive dissonant thinking claims that buying the superior track record or at the cheapest cost is the key to successful investing.

That argument is seductive but a lie nonetheless. The truth is, investor returns are almost always lower, usually dramatically lower than the investment itself.

How is this so? When the so-called superior track record lags (as it invariably will), the investors who are left to themselves (or worse, left to the press), will simply sell the fund. The fund will go into liquidation as investors receive their quarterly or yearly negative performance results. Add a major financial event - a recession, financial crisis or the latest apocalypse dejour – and the fund, index, ETF, etc. goes into panic liquidation.

To illustrate what I mean, here is a straightforward chart for your review:

The chart consists of a major U.S. stock market index (S&P 500 Index) along with money flows in and out of stocks and bonds.

First, some explanations: Equity funds refer to mutual funds containing stocks, and bond funds, logically enough, are mutual funds containing bonds.

The jagged line represents the value of the stock market index (based on a $10,000 investment) and the solid green areas represent money going in or out of stocks. The solid gray area represents money going in or out of bonds.

There is a couple striking things about this chart. Note the massive inflow into equity (stock) mutual funds around the year 2000 or just before. Note the massive outflow of money out of equity funds in 2009, 2011 and 2012.

Initially, this looks very puzzling. Why would money be exiting equity (stock) mutual funds at the same time the stock market index (S&P 500) was soaring? Shouldn't money be going into stocks? Logically speaking - yes it should, but logic has nothing to do with it. Instead, the money continued to exit stocks and went into bonds. However, that is another discussion for another time.

By the end of 2012, the S&P 500 stock index had more than doubled from the lows reached in 2009. Currently, at the time of writing, the S&P 500 is some 152% higher than the 2009 low.

If you look at the chart, the majority of investors bought stocks at the peak of what was the technology/internet mania of 2000 and again, a majority of investors sold their stocks from 2009 (the U.S. Financial Crisis) onwards.

According to the chart, in dollar terms, investors paid almost $60,000 in the late 1990's, and sold the investments in 2009 - 10 or more years later - in the high $30,000 area. We'll call it a loss of about one-third of the investment in 10 years.

A good investment adviser knows that picking an investment out of the newspaper with a "superior" track record is a fallacy and an unattainable target. The superior track record of the S&P 500 stock index just earned you a 33% loss in a 10-year period. Buying or selling at inopportune times will destroy the so-called superior track record every time.

What we do with our investment after we've bought it is the true key to investment success. Advisers who understand behavioral economics can help mitigate these inappropriate and deadly investment behaviors. And as Nick pointed out many years ago:

"We see that investment success is not primarily determined by investment performance but by investor behavior."

If you are reading the above sentence, please do re-read it. You should be having an "ah-ha" moment right now.

Be warned though. The Great No-Help Lie is always around us, re-phrased slightly here or there by the media but just don't believe it. Not even for a second.




Cognitive dissonance

I had to do a double take as I was listening to the comments of a high-profile securities lawyer who said, "Yes, of course. We must absolutely have stricter regulations for Canada's brokers because of - you know - the Financial Crisis..."

Wait a second. Let's rewind the tape.

First of all, the U.S. Financial Crisis had nothing to do with stocks or Canadian financial advisers in particular. It was a real-estate/sub-prime crash in the U.S. not in Canada.

The stock market was a victim, not the cause of the U.S. Financial Crisis. When a mortgage is way higher than the value of the house, really bad things start to happen. Please re-read "The Big Short", "Bailout Nation" or other books about the causes of the Crisis. We will have a test afterwards.

Even though I am an optimist by nature, personally, I do not think there is a cure for persons affected by financial amnesia or cognitive dissonance. However, financial amnesia and cognitive dissonance disorder (CDD) have remarkably many of the same symptoms.

Although the clinical psychological definition of "cognitive dissonance" is often expressed as "the feeling of discomfort that results from holding two conflicting beliefs", the term has acquired a different meaning. It generally refers to a person that has seen, observed or been given irrefutable proof of something yet refuses to change one's beliefs by rationalizing away the proof submitted.

Example of cognitive dissonance:

A person believes that cannon balls float.

Even though the person participates in an experiment (by dropping a heavy cannon ball in a pail of water - which promptly sinks), the cognitive dissonant person will insist that cannon balls do float and that the experiment is somehow rigged or defective. Please note that cognitive dissonance is not a function of a person's IQ. People who think they are really smart are often victims of CDD. Curiously, victims of CDD will almost always vehemently deny they have the disease. They can still function in society (to a degree) and can often obtain gainful employment in politics, media, the legal field or public relations.

I am sure that everyone has met or known of at least one cognitive dissonant. Please join me and start a movement to stamp out cognitive dissonance before it runs rampant. Hopefully, we are not too late!


CRM2 - Big regulatory changes coming to Canada's mutual fund industry

What Canadian mutual fund investors need to know

CRM2 is short for "Client Relationship Model - Stage 2. Regulators have passed new rules that came into effect July 15, 2013. Some became effective on that date but many will transition over a 3-year period. While CRM2 refers to some changes regarding the sale of other securities, I will restrict this discussion to how CRM2 affects investors who are interested in buying mutual funds, and investors who currently own mutual funds.’s summary of the new CRM2 regulations is as follows:

"For example, starting on July 15, 2014, firms will have to provide pre-trade disclosure of charges, and disclose their compensation from debt transactions in trade confirmations; in 2015, enhancements to client statements will be introduced, which will provide position cost information and market value under a set methodology; and, in 2016, firms will have to begin delivering annual reports on charges and other compensation and an annual investment performance report."

A copy of the actual regulation can be found here:

The changes have been described by securities lawyers as "complex".

I previously suggested that a new pre-sale disclosure document would be best discussed verbally and in writing; both parties would also be required to sign off on the document. Both parties would have to declare that all regulatory disclosure requirements have been discussed orally, and that the client has both heard and understood what they mean. The client would also have to declare that they have received a copy of the pre-trade disclosure document.

Unfortunately, the new regulation only optionally requires a verbal discussion or written disclosure. I don't think it quite went far enough.

Also, it is unclear as to how frequently this discussion must occur. If you are a new client, you would want to know how the fund works and how much it costs. If you come in next month to add some money to an existing fund, would an adviser still be responsible for going through the same required disclosures?

One of the new requirements is for advisers to disclose their own compensation, including possible future compensation but there is a problem here again. Advisers must divulge their compensation in a pre-sale discussion. However, the new statements required by the new regulations detail the adviser's firm’s compensation. I can assure the reader that the firm's compensation is not my compensation! An adviser receives only a portion of that number. This will very likely cause confusion when the client is mailed an annual summary of the firm's compensation.

The regulator says this will all be good as it will encourage a discussion and dialogue. I do not agree as the information presented to the client could be confusing. If the intent is to have an informed client, firms and advisers will need to clarify the confusion that will invariably follow. Look for lots of extra asterisks on your statement.

The new statements will display original cost or book value. Unfortunately, the regulator did not choose to be consistent with the proposed changes in reporting, and made it optional for the firm to choose one or the other. Book value causes more confusion among clients than anything else. Book value consists of original cost of the investment plus re-invested distributions and possibly other things. Clients almost always mistake book value as their original cost. More asterisks needed.

One of biggest changes that firms must make on their client statements is to provide a personalized rate of return for every account.

This requirement, in my opinion, is nice to have but from a technical viewpoint, will be somewhat nightmarish to implement. It will be costly. Industry wide, I believe it will be tens of millions of dollars or more. Additionally, I have concerns that most of the new ROR calculations will be inaccurate.

For students of the time value of money (I am one of them), a rate of return is a sort of elusive mathematical target. There are many different ways of calculating it and mathematically speaking, it is possible to have two or more different rate of returns for the same investment!

The regulator has decided that money (dollar) weighted rates of return is the new standard. 

As every adviser knows, when an account is transferred because the client is changing advisers, or the adviser is changing firms, the new firm would base all of their reporting on the current market value of the assets which would completely ruin the ROR calculations, even though the client’s portfolio had not changed. Therefore, having a new requirement for ROR calculations is nice in theory but difficult/impossible in practice.

The new pre-trade discussion with your advisor has to involve a discussion on his compensation. On your annual statement, you will see a lot more information about the dealer’s (the adviser's firm) compensation (in dollars), the amount of money coming in and going out of your account, and rates of return. Your dealer’s annual statement will start to look similar to the annual statement that the mutual fund companies have been mailing to clients for many years now. 

There appears to be a big question mark regarding consolidating rates of return. The regulator demands ROR for each separate account but I did not see any guidance about consolidated rate of return calculations.

If a client asks, “How am I doing overall?" I am not sure if we would be allowed to answer that question.

In reviewing the total package of new regulations, I can say that there are some improvements here and there - some good, some not so good.

As to the reasons why all of these new modified regulations - I am not so sure. The CSA wants to establish itself as our national securities regulator despite the Supreme Court of Canada saying otherwise, so the answer might be political. Although I have been always a strong supporter of a national securities regulator, the CSA's first big foray into the mutual fund regulatory world, to me, has been somewhat of a rocky debut. The new rules apply to mutual funds sold by some firms but not all. As a result, many firms will be at a great competitive disadvantage.  Therefore, I do not agree with the CSA’s reasons that Dealers must bear the pain of increased costs, more paperwork, and more complexity while our competitors across the street are exempt.

If you are a financial journalist or investor advocate who demands more regulations one day and then demands lower mutual fund costs the next, who ultimately is going to pay for these millions of dollars of additional costs? We all know the answer - the consumer ultimately pays.

Will the above regulation change the sales process? Yes, it will but only very slightly. Loads, DSC fees, fee-for-service and account charges are currently being disclosed in the pre-transaction discourse with clients, and most advisers already discuss trailers with new clients. Even though trailers are already disclosed in writing within the fund materials (prospectus) given or handed to the client, trailers must now be discussed pre-trade by the adviser. 

Will the new rules change the way an adviser ensures that an investment is suitable and appropriate for a client based on their personal situation? No it won't - we're doing that already.

As I mentioned in my previous article, I suspected that Canada's national regulator would increase the pain of investing and inadvertently discourage investing in general. After reading the new regulations, I believe they are well on the road to do so.

Errata: A sharp-eyed reader has correctly pointed out to me that CRM2 rules do allow for consolidated rate of return calculations but only if the client provides written permission to do so. If we do not have written permission, we presumably would not be allowed to provide consolidated rate of returns.

Additionally, the definition of “account” may need to be clarified as many financial institutions refer to an account in different ways.

A client, for instance, could have a client-name mutual fund account in a plan (like an RRSP, for example), a regular plan, a spousal RRSP, RRIF, etc. In this type of “tier”, the client could have multiple plans within an account.

Most dealers, securities firms, and other financial institutions also have nominee (self-directed) plans. These operate very differently than client-name accounts, which again add some complication regarding the definition of an “account”.


Great Rotation - revisited

Race for the exits?

I saw a comment from Dynamic Mutual Funds this week [week of June 10th] They are tentatively saying that the Great Rotation [1] may have begun.

Another mutual fund firm, AGF, advises me that May 2013 bond fund returns have turned decidedly negative.

Even the press is starting to pick up the story of a possible big correction in the bond market.

Lately, asset managers, advisers and other financial professionals seem to be glued to their computer terminal screens watching the U.S. 10-year Treasury note yield.

It has made a 1-year high. Remember, as the price of the bond drops, its yield increases. Despite the inverse relation between price and yield, like stocks, bonds are the same - you do not want to see the price drop on your investment!

Unless declining bond prices are making headline news, investors may not notice until January 2014 when they are reading their end-of-year 2013 statements.

Currently, I do not have any large bond positions in my portfolios. which might be a good thing if U.S. interest rates continue to rise. Although higher interest rates is great news for GICs, higher rates are bad news for existing bond holders who may lose money if the price of their bonds continues to drop.

What bond mutual fund holders and balanced mutual fund owners need to know

If you see words like "bond", "income" or "yield" in your mutual fund statement, you likely have bonds in your portfolio. This is important: higher interest rates are bad for bonds (think teeter-totter effect) as rates and bond prices go in opposite directions.

There is still a debate as to whether or not bond prices have temporarily dropped or have started a more permanent decline. If there is a stampede out of bonds, this could mean that a lot of this money might go back into the stock market. Because there has been large upward price movements in both stocks and bonds in the last 4 years or so, I am recommending that you contact me in order to determine if you may be over-concentrated in one area or another and also determine if any changes need to be made to your mutual fund portfolio.

Please contact me at or call me at 519.744.3020 in order to schedule an appointment. 

[1] "Great Rotation" – Investors massively piled into bonds during the last four and a half years. The "Great Rotation" refers to the possibility that this huge amount of money in bonds will be "rotated out" and switched to stocks.


Adviser fees - the pain of paying

I don't know about you, but I am rarely overjoyed when I go to the mailbox and return with a handful of bills that I have to pay. I am even less enthused when I am forced to pay a new fee where there were none previously.

If the press have any say (they do), our regulators may do exactly that. Investors could soon be receiving bills for the mutual funds they own.

Shortly, regulators for Canada's mutual fund industry will likely announce big changes to the way we buy or hold mutual funds which in my view, could be detrimental to the average investor's best interests.

Under the current traditional commission structure for mutual funds, very few investors pay any up-front commissions to buy mutual funds.

If there are no commissions or if funds are purchased at 0% commission, are mutual funds free? No, of course not. Adviser funds have the adviser's remuneration built into the price of the product. What this means to the investor is that the mutual fund company collects the commission at source, pays the mutual fund dealer (the adviser's head office) where it is split between the dealer, the branch office (where the adviser works) and the adviser, then keeps the remaining commission.

All mutual fund performance reports and rates of return include the adviser remuneration. Therefore, the rate of return listed on your end-of-year statement is the real and actual number.

Although this system has worked successfully for many decades, and in my opinion, is fair and equitable, it has recently come under fire by the press who has gone as far as saying that all commissions are abusive, unethical and must be banned.

I find these public comments to be preposterous, incredulous, and inaccurate.

In a previous article, I offered a solution where commissions might be called fees instead. Somehow, in the view of the press and perhaps the regulator, fees are OK but commissions are not.

Why prefer fees over commissions? Stocks have had commissions for centuries, bonds have commissions, houses have commissions, and even GICs have commissions. Some investments, like GICs have embedded commissions - commissions that are built into the price of the product. The client who is buying a GIC from a broker really has little interest whether the selling broker is making a commission or not. They are however, interested in getting a better interest rate than their bank!

Here's a real world example: You can buy a GIC 1-year term from a local bank branch today and receive 0.90% interest. Bank staff do not earn a commission for selling this GIC to their customer because they are on salary. However, if you bought a GIC from a broker, you could easily obtain 1.80% - double the interest! However, the press would object to the practice as unethical and abusive because the 1.8 % includes a small embedded 0.2% commission for the broker.

Logic apparently does not seem to apply in this strange investing universe. The investor gets double the return but this is apparently bad because the broker has earned an embedded commission!

[Editor's note: Some readers may be tempted to point out that the CSA is targeting only mutual funds, but I have heard this may not be the case. The CSA may also be looking into how GICs are sold.]

To embed or not to embed - that is the question.

As far as I know, no one has thought to bring in behavioral economics into the discussion. In their quest to reform the industry, the regulators (or the press) do not appear to be looking at the impact on basic investor behavior. For instance, will un-embedding commissions and replacing them with fees encourage investing or discourage investing?

I asked world renowned behavior economist, Dan Ariely [1] the question, "How would the proposed new fees affect investor behavior?"

Dan's answer was startling. Actually he answered my question with a question:

"Maybe people will not seek advice if they have to pay directly. If they pay directly, they will be definitely much more upset."

[Editor's note: Now we know why non-adviser mutual fund firms are chomping at the bit to ban commissions. They know all too well, that many investors will refuse to pay direct fees to advisers. Therefore, it would be in their best economic interest to have commissions banned in order to destroy their competition.]

Behavioral economics has become increasingly important, especially with respect to actual investor performance. Study after study has shown that the average investor badly and drastically underperforms their own investments by essentially repeating irrational, but predictable behaviors. If we can be made aware of these behaviors (by your adviser, perhaps), then hopefully we can become better investors overall.

"Whatever you do, I think it's clear that the freedom to do whatever we want and change our minds at any point is the shortest path to bad decisions. While limits on our freedom go against our ideology, they are sometimes the best way to guarantee that we will stay on the long-term path we intend." -- Dan Ariely

I definitely recommend reading Dan Ariely's bestselling book "Predictably Irrational" for more background information. One of Mr. Ariely's recent studies concerns the "pain of paying" where he gives a number of actual examples. For instance, you might want to increase the "pain of paying" to help curb overspending. To do this, you would pay everything in cash rather than use a credit card. See Dan's video as to why this is effective. However, for some things where you want to encourage consumption (like investing perhaps?), you want to lessen the "pain of paying" - not increase it.

The press and the Canadian Securities Administration of course, always have the best intentions. They want to see investments conflict-of-interest free, everything open and transparent, and believe that investors should be completely financially literate with respect to their investments.

But I think they missed something quite important. Sure, markets are making record highs and some clients might be willing to pay fees if their account balances are going up every month. However, what happens if the stock market stalls or goes into a big 60% decline like in 2009? Suddenly, we now truly understand the "pain of paying" and there will be no doubt that there will be lots of pain in the next market downturn - whenever that might be. The pain of seeing your life savings cut in half (or more) plus to add insult to injury, you receive your broker's bill for advice in the mail. My view is that investors will revolt and refuse to pay by not investing.

"If someone has say, $1 million dollars in a bank account, savings account, retirement account and pays 1% asset under management a year, he probably is willing to pay. But if he had to pay directly, exquisitely $10,000 a year, he probably will not do it."—Dan Ariely

I think Dan Ariely nailed the argument right there. I think what he is saying is that the investor is willing to pay an embedded commission because likely, the investor inherently knows an adviser has a cost element attached to it, but the investor is not willing to pay an un-embedded fee/bill for the same amount of money. The client would prefer a built-in commission over an open, transparent but exquisitely painful bill.

What we can conclude at this point:

1. According to arguably the world's foremost expert in behavioral economics, the questions may very well be, "How many investors are going to stop investing entirely or are not going to be put in the correct investments? How many investors would just stop saving?" As Mr. Ariely notes, the abject aversion to fees may cause fees to drop overall as investors may refuse to pay them. Normally, in a capitalist society, this might be considered a good thing, but there are other consequences that he describes as "terrible".

2. As a result, the regulator may be inadvertently harming the client with the good intention of improving things not realizing that these good intentions may lead to catastrophic results.

In effect, behavioral economics tells us that we may be actively discouraging consumption of a product/service just at the time we need it the most. Additionally, we can also conclude that there is no benefit to the investor by forcing them to pay directly, and there is no benefit to increase the pain of paying for a product which we need to be consuming.

We may further conclude that not only is there no benefit to making these changes - we may actually do harm to the client and discourage investing in general.

Clients may have spoken but they are not being heard. They want an all-in-one investment that is simple and easy to understand without all the jargon. They would be happy (perhaps) to receive a piece of paper with all the disclosed costs and adviser remuneration. Although this is already being done, the document currently in use, is overly long and complicated.

The regulator can play a key role by shortening up massive legal disclosures now in existence and condense them to one or two pages. Advisers could be required to verbally disclose all these details and to also ensure that the client understands; the regulator could also require the adviser and the investor to sign off on this important document.

Rather than legislating a one size must fit all solution, give clients the choice. Simplify the disclosures and shorten the documentation. Give the client the option to keep the current embedded all-in-one pricing or choose to be billed in a fee-based account. This is the system we use now. This is a far more flexible and fairer solution which offers the best chance of matching a client's financial needs with an investment product or service that best suits their particular situation.



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