Tag Archives: guidance

Power Corrupts, Entitlement Corrupts Absolutely

  • “Power tends to corrupt, and absolute power  corrupts absolutely.” – Lord Acton, 1887
  • “Unlimited power is apt to corrupt the minds of those who posses it.” – Earl of Chatham, 1770 

In light of recent events (Tiger Woods, anyone?), many would believe the above statements to hold true.  It seems, in our society, that increasing power inevitably leads to a complete erosion of moral and ethical boundaries.  Consider former US Attorney General Elliot Spitzer, or Senator John Edwards preaching family values as a campaign slogan while committing adultery.

However, power may not be the entire story.  I recently read an article in The Economist (Jan 23-29, pp. 75-76) that looked at a study by two professors (one in Europe and one in North America), who conducted a series of experiments to see if this was indeed true.  In the tests that they organized, they arranged so that one half of the group felt entitled to their power, whereas the other half did not.

What they found was interesting.  The research suggests that the individuals who were made to feel entitled to their power were far more likely to commit immoral or unethical acts than the group that was led to believe that they did not deserve their power.  In addition, the research went on to consider the actions of those in power who did NOT feel entitled to the power they were given.  Not only were they more likely to be much more harsh in the judgement of immoral acts, but as a group, they were also more harsh on themselves when judging their own acts than on others.

Huh.

So why did I bring this up in the money column?  I think that this is a very strong analogy about how people, and specifically children, act when confronted with money (note: this is my opinion now, but go with me here).  I have seen many clients come and go, and come to know their families relatively well over the years.  I have also listened to many people speak about the plans they have for their retirement and estate plans, and most feel that leaving “too much” money would have a negative effect on their families, or more specifically, their kids.

So how do we teach kids about money and responsibility?  There are loads of fantastic resources around the web.

However, we are often so preoccupied with saving and spending wisely ( heck, that is what this column is designed to discuss! ), that we fail to consider whether or not our culture (I must have this video game/car/home/toy/etc.) is making our children to feel entitled to the money that their families earn.  Parents may work their fingers to the bone to earn this stuff, but there is likely no activity, strategy or website that will teach them the importance and impact of money unless they learn they will have to earn it, not that they deserve it.

Investment Management Fees – Buyer beware

Now that you are looking towards the future, and perhaps are beginning to take a serious look at your long-term savings options, let’s take some time to understand how you might be charged (and how you can avoid) fees as you invest.

For some, fees will be paid to an advisor involved at some point in the process.  That advisor might be a planner or a broker who takes commissions or trailer fees as a result of managing a clients’ account.  Or, fees may be paid to an investment manager, either indirectly through ownership in mutual fund, or directly as a result of a discretionary or segregated account with that manager.

Essentially, the amount and type of fees you pay are what determines the kind of practice your investment advisor runs.  Instead of just asking “how much” the fees are, perhaps examine the types of fees you are paying, why you are paying those fees, and what incentive it gives to the recipient of those fees.

Trading Commissions

By far, the most common method of compensating advisors is still commissions.  However, all commissions are not created equal.  There are basically three types of commissions:

  • Brokerage commissions: when trading securities, a fee is charged based on the size and type of trade.  Some brokers will pre-arrange a fee schedule for their clients that provide a certain number of transactions for a fixed cost
  • “Spreads” on Bonds:  Many investors are unaware that there is a commission paid on a bond.  That commission is called the spread, and it is the difference between the actual rate being paid on a bond, and the rate at which it is sold to you.  For most bonds the spread is between 10 and 25 basis points (0.10% and 0.25%).
  • Mutual Fund “Front End” commissions: when an advisor recommends a fund, the client is charged a percentage of their investment in order to purchase units in the fund recommended.

In all cases, the commission here is a fee paid as a result of a transaction.  Make sure that, when you are working with an advisor, you are comfortable with what those commissions mean.  This method will reward the advisor when you act on their advice.  So, it is reasonable to say that their bias will be to implement a portfolio solution that prefers transactions.  If you are an active investor, then this will compensate an advisor who continues to bring quality investment ideas to you.  However, if you are an inactive or conservative investor, you may feel that you are pressured to take action that you do not feel is in line with the objectives of your portfolio.

Deferred Sales Charges

Mutual Fund “Back-end” commissions are a contentious topic among investment professionals and the investment public.  These “deferred sales charge” occur when a client purchases a new fund within a mutual fund company.  The advisor is paid a commission by the fund company, but the client is required to remain with that fund family for a certain period of time to account for those fees being paid, usually either 3 of 6 years.  After the first year, those funds pay a trailing commission to the advisor of roughly 25 to 50 basis points.

The upside is that there is no immediate cost to the client.  In addition, the commissions paid are usually either 2.5% or 5.0%, and this allows advisors to receive compensation from smaller accounts, and enables them to spend the appropriate time with those smaller clients to deliver proper advice.

I believe that the significant downside, however, is that this form of compensation provides incentive for advisors who meet and satisfy new clients, rather than existing clients.  If an advisor is being paid 5% on a new client and 0.50% on their existing clients, the attention of their practice is likely biased towards the initial portfolio set-up, and not necessarily the ongoing management of your account.  If your advisor recommends the use of these charges, ensure that you are comfortable that you will continue to receive the same quality of advice into the future.  In addition, your advisor should not be asking you to re-invest in deferred sales charges again once the deferred sales charge period is over.

No Load

No load compensation schedules are generally by advisors working with mutual funds, and are intended to mimic the type of compensation schedule that investment managers receive (see below).  The no load schedule means that the advisor receives their compensation as a percentage of the assets they have under management.  This means that their bias is towards maintaining the assets they already have, as there is no extra incentive for them to attract new clients, and there is nothing stopping them from leaving if they are unhappy with their service.  These are a form of servicing commissions, as above, but are the only form of fees these advisors receive for clients invested in these funds.  Thus, their bias will be towards more inactive clients.

Servicing Commissions

Servicing commissions are fees that are paid by fund companies (generally) to advisors for maintaining the accounts that they have.  Servicing commissions vary depending on whether the advisor has recommended a front end load, no-load, or deferred sales charge fee options for their clients.  Reasonably, these are the fees that the advisor receives for maintaining your account over the long term.  These are also referred to as “trailer” fees.

Investment Counsel Fees

A direct relationship to a discretionary portfolio manager usually means a fee schedule much like the “no-load” schedule described above.  These fees are usually lower, as a result of the size and structure of accounts being managed.  In addition, it is generally accepted that these fees are tax deductible for non-registered accounts (although taxpayers are advised to consult their tax professional to ensure this is the case for them).  The fees paid to these managers can also be mixed with an incentive fee of some sort, such as a share in a percentage of profits.  This is more commonly found in managers with higher risk or specialty mandates.  There are a variety of “retail” solutions like this that are available to clients through advisors that mimic this relationship.

Your Objectives

If your objectives do not fall in line with the method in which your advisor receives fees, it will be difficult for you both to see eye to eye on an investment strategy.  The fee discussion tends to raise the blood pressure of both clients and advisors alike (for different reasons), it is a discussion that you must have with your advisor, and you must be comfortable with as a client.

Good quality advisors are likely going to give good quality advice to their clients, regardless of the fee schedule.   However, even good quality advisors are running a business, and the business decisions that they have made about their practice are going to impact how they deliver their advice in the future.

Tax Free Savings Accounts

The government of Canada gave us Canadians another tax savings option in the 2008 federal budget that will go far in helping Canadians accumulate wealth in a tax-effective manner.  The Tax Free Savings Account is quite simple, and the features of the plan are as follows:

  • It is open to all Canadians over the age of 18, and continues for life.
  • The maximum contribution into this plan will be $5,000 per year. That amount will be increase with inflation in increments of $500 in future years.
  • There is NO tax deduction available for deposits.
  • All income and growth is exempt from taxation, even on withdrawal.
  • Unused contribution room can be carried forward.  If you make a withdrawal, the amount withdrawn can be replenished to the account in subsequent years without any penalty.
  • As with an RRSP, the plan contemplates spousal contributions without affecting the contribution room of the spouse receiving the spousal contribution.
  • TFSA can then be used for whatever purpose at whatever time. (buying a house, paying for a wedding, starting a business, etc.).

We think that every Canadian over the age of 18 should have this account. For the time being, your TFSA balance will be small, and that will limit your investment options, but it is a great place to hold any extra cash – since the account has no penalties to your “room” when you withdraw, you can move funds in and out without penalty.  And, with interest rates at record low levels, we need all the help we can get on interest savings after tax and inflation are taken into account.

Here are two strategies that you can implement in the future:

  • Lower income taxpayers: for taxpayers who are saving their money while earning a lower income, the TFSA is a better deal than the RRSP (i.e. for the spouse during maternity leave). This is because the positive effect of the RRSP deduction is less if the taxpayer has a lower income tax rate (lower tax rate = lower amount of tax back from your RRSP deduction). If an individual is in a situation where they expect to be earning more in the future, then the TFSA would be a far better choice, and the taxpayer could carry forward RRSP room for future deductions, hopefully at higher tax rates.
  • Funding Education for Adult Children: parents might consider funding more of a child’s education on the agreement that the adult child save the equivalent amount in their TFSA. This would allow the parents to take all relevant deductions and credits for funding their children’s education, and it would allow the children to begin to accumulate savings in their own TFSA. They are likely earning a very low income as a student, their contribution to the TFSA will come at a very low after‐tax cost.
  • All in all, I think that the TFSA is a good move for Canadians. If for no other reason, it simply provides you with another planning tool. If the tax benefits are not enough to persuade you, then the added planning options and flexibility should.

Do I really Need Life Insurance?

Yes, you do.

As a parent, life insurance is a necessary part of planning, because it takes care of your family if something happens to you.  It is not an enjoyable topic, but it is something you should look into.  You will likely be surprised at how inexpensive a program can be.  The big questions is “how much should I get?”  That is different for everyone, but basically, there are three main reasons we buy life insurance:

  • To pay off debt (usually the mortgage and/or student loans)
  • To replace the lost income of the person who is gone
  • To pay for expenses what may arise when one or both parents are gone.

In the first example above, the amount is easy to understand.  If you have a mortgage of $200,000, you should have a corresponding amount of insurance to pay off the debt should something happen.

Replacing lost income is a bit more complicated.  What industry experts recommend is that you should have approximately 60-70% of your family’s annual income available should something happen to either spouse.  So, if both parents are earning $50,000, the family income is $100,000.  If something should happen to one of them, then there should be funds available to create an additional $10,000 to $20,000 per year, likely until the kids are finished at least high school.  If the children are young, this could mean that the surviving spouse needs this income for 15-20 years.  The insurance amount for this situation would be to create a benefit of $150,000 to $250,000 in the event that one of the two income earners is gone (this would be in addition to the insurance that is earmarked for debt repayment).  Here are two calculators to explore – Sun Life, LSM Insurance or there is a good one available at the Bearing Capital Partners website.

Finally, families should consider the added costs to the family if one of the parents is gone.  Will there be an increased need for daycare or housekeeping as the surviving spouse continues to work?  This could cost an additional $15,000 to $20,000 per year, depending on the number of children, etc.  For two children, a working single parent would need to have some kind of back-up, and we estimate that cost at an additional $15,000, until the kids are 16.  This would be funded in much the same way as the lost income, and would require approximately $100,000 to $200,000 (in our example) of insurance benefit.

Last, you might want to consider adding some small extras, such as an education fund and some final expenses, in order to deal with added burdens to the surviving spouse. The big question is “where do I get this stuff?”  There are two sources.  First, your company employee benefits plan likely has some kind of benefit, and there might be the opportunity to apply for more.  These company plans tend to be less expensive, but you run the risk of losing coverage if you leave your employer.

Your other option is to find a licensed insurance broker who can take you through the options.  Most young families should consider term insurance, which is an inexpensive method of providing a benefit.  There are other plans that have more permanent options, and that build up an investment value over time, but these can be looked at later, when you have some excess savings.  The important thing is to get some insurance in place and make sure that everyone is taken care of.

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If you are looking for a place to learn and grow as a person, a parent, a spouse, a partner, an employee, an entrepreneur or global citizen, you have come to the right place. HeadsUp Dad is here here for you.

Heads Up Dad is a support community for highly engaged and active Dads, wherever they may be. A resource pool of useful tools, interactive content, articles of interest and other illuminating stuff all designed to make the world a better place by helping Dads and Dads to be learn, grow and become the best we want to be.

Traditional Family dynamics have been changing over the years— so much so that modern day Fathers are increasingly evolving in their roles from traditional hunters and gatherers to become stay at home nurturers when the kids get sick, caregivers, support workers, cooks, cleaners, shuttlebus drivers, psycho-therapists, guidance counsellors and still, the charismatic and larger than life hero who is supposed to go out every day, change the world and bring home a paycheque.

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