In the pursuit of wealth, most are naturally drawn to the financial industry. After all, financial product advertisements and financial news can be seen everywhere!
There are magazines, blog posts, and 24/7 TV shows(I confess I used to watch the “Lang and O’Leary Exchange” daily, and was excited when Kevin came to Kamloops). The business section of newspapers are dedicated to the financial industry.
The amount of content out there is overwhelming, with more opinions on finances than options!
After mucking around with the noise in the media for a while, I decided to get educated.
I frequently say the Canadian Securities Course(CSC) is the best $1000 I have ever spent. I’ve learned what the financial industry is, how it works, and most importantly, how it affects middle class working people like me.
About the CSC
From the Canadian Securities Institute website: “In Canada, individuals who sell financial products […] OR have specific duties within a financial services company […] are required to meet educational, employment and work experience criteria in order to be licensed.”
The CSC is an intense program if your discipline isn’t in finance. Few aspiring advisors pass CSC exams on the first try with a 30-60% pass rate depending on the year. There are over 705 pages of content(I bought the audio book to help me through it, about 30 hours of audio that I listened to multiple times), lots of formulas to know, and many practice tests to complete for a good chance at passing the final exams.
Here is a picture of the table of contents:
As I was writing this post, I reviewed my study material and found my old notes/formulas. I had condensed them into a single sheet, and practiced copying the sheet until I could reproduce it from memory. When I started the exams, the first thing I would do is reproduce my cheat sheet. Here is what the various versions looked like:
In 2011, I completed the course on the first try. I am proud of that, although I cannot find my certificate, it must be in a box somewhere waiting to be framed and hung.
7 Revelations After Completing the CSC
Once I completed this course, I could see the big picture of the financial world.
Here are some insights I learned that will help you protect your money.
1. The financial industry deliberately complicates simple concepts.
I learned that the financial industry uses an alphabet-soup of acronyms(MER, GIC, REIT, RRSP, HFT) and other jargon to complicate what should be very simple.
Financial markets can be summed up as follows:
– You can buy shares in companies(stocks) to participate in growth of those companies,
– You can loan money to government or companies(bonds) to collect interest on the debt, or
– You can spend money betting a financial instrument will rise or fall in value (Derivatives) such as Puts/Calls/Warrants. Most securities that are not equity or debt are called derivatives.
Derivatives are frankly a mess of different types of wagers. It’s like a group of gambling addicts have decided to bet on anything they could think of, then sell the bets to investors.
Investors, not understanding what they are getting into, buy these derivatives on the advice of
advisors salesmen(more on this later so keep reading) who are seeking a commission. Soon, not even the architects of these products understand what it is exactly they are selling.
2. The house always wins.
When complicated financial products are invented, typically only the inventor of that product makes any money.
For example, Goldman Sachs sold investors risky mortgages in ’06/’07, while at the same time betting on a housing crash. So they made money both ways.
That is like if I bet on a horse race, then sold you my ticket after I learn the horse is lame, and then place a bet on the competition. The party who sets the stakes is also rigging the game.
Take High Frequency Trading(HFT) as another example. When you click your mouse to purchase a stock in your self directed trading account there is a lag time, known as latency, between when the order is placed and when it is filled(the stock becomes part of your portfolio). Your fiber optic internet connection is 30% slower than the speed of light, but HFT companies often use microwave technology(with large antennae or even high flying drones and satellites) which is only 1% slower then the speed of light. So, when your order is detected by a high frequency trader(a computer program), they purchase the stock ahead of you, then sell it to you at a higher price, pocketing the difference.
Complex products(derivatives) or strategies(HFT) seem to serve no purpose other than to separate investors from their hard earned money, and are very common in the financial industry.
This becomes even more evident in the next revelation.
3. There are more funds(a mixed bag of companies) than real companies on the stocks market.
But there are 35,323 Canadian “funds and clones.”
For every 1 actual company that is making something or servicing someone, there are about 9 mutual funds, with each manager trying to find a mix that will “beat the market”.
There are $1.12T of mutual funds, to put that in perspective the TSX had a value of $3.5T June 2014. Over 1/4 of Canadian wealth is held in mutual funds.
What is the problem with this?
It’s called Management Expense Ratio: The financial industry’s name for a fee, aka MER. Why not just call it a “fee” rather than confuse the matter…
Anyway, the average MER is over 2.5%, representing $30 Billion in fees paid, funneled away from investors.
With average stock market returns of 8.5%, that means your average return within a mutual fund is more like 6%.
But that’s if you’re lucky….
4. Portfolio managers cannot consistently beat the market.
Do you think paying fees to an expert will get you a better result than just tracking an index? Think again.
This article make the point quite succinctly:
How common is it for investors to pay fees – maybe even rising fees – for indifferent or worse returns[than an index]? “Out of all the mutual funds I cover, I would say 25 per cent are pretty decent,” said analyst Dave Paterson of D.A. Paterson & Associates. “You’ve got another 50 per cent that are acceptable, but you might as well be in an ETF, and 25 per cent that probably shouldn’t be sold.”
So, should you should just buy an index product, or ask your investment advisor to help you find the best mutual funds?
Not so fast, keep reading.
5. The financial industry is largely devoid of ethics.
The financial industry is structured to take care of it’s own interests first, not yours.
Let me elaborate.
Pretend advisors actually want to help you(some do). They are frequently tied to the financial products of the bank/brokerage they are employed with. They may not be able to offer you the best option for your situation because they are simply not aware it exists, and are just acting as sales representatives.
And that’s if the advisor wants to help you!
Of the 705 pages of content in the CSC, only 27 pages(3.8%) deal with how to best service the client. Only 9 pages(1.3%) are devoted to ethics.
So, when dealing with any financial advisor, keep in mind that the entry level licencing course material contains LESS THAN 4% on what’s in the best interest of the client(YOU).
These are the people who influence major decisions of Canadians just like me and you.
Decisions that will affect your family, your retirement, your child’s university fund, your ability to contribute to the world and leave a legacy. These are profound and intimate hopes, dreams and goals.
The financial life of millions of Canadians is in the hands of someone who may have spent less than 1.3% of their formal training learning about ethics.
This leads to the most disturbing revelation…
6. The financial industry is rife with fraud.
More than 1/3 of Canadian organizations report being victimized by white collar crime, and an estimated 7% of publicly traded firms are affected by fraud. Canada has a reputation for being a haven for white collar criminals.
The reason: Each province/territory has its own regulator(in BC we have the BC Securities Commission).
The result: Lax enforcement of securities legislation between jurisdictions.
How this affects you and me: Products are frequently sold that are not in the best interest of the client, only the
advisor sales person. This is unethical, and at times unlawful.
For example, financial companies who’s business models involve pyramid selling thrive(the ethics of this business model are best reserved for another post).
These companies recruit a host of unsophisticated “associates” with promises of riches. The “sales associates” are encouraged to sell the company’s financial products to friends/family, and to recruit them into the network as well. The only people who end up rich are the founders of the company, everyone else is lucky to break even.
Pyramid selling results are predictable:
A crook gets banned from scamming people in one province, using what was learned from others who had used the same tactics and were disciplined in the past, and the fraud is repeated over and over.
IMET, Canada’s market enforcement team since 2003, have a dismal track record due to different regulatory bodies jurisdictions, and other structural weaknesses in Canadian securities law. It is for this reason there so much fraud in Canada appears to go unpunished: take the Nortel acquittals for example.
So, are there options to find a good investment for the middle class?
Yes but they require more active involvement than a 1/2 hour meeting with an
investment advisor mutual fund salesmen. Do this:
– Get educated(read – Warren Buffett etc…, take courses, study).
– Pay fee-for-service advisors(non commission) for advice.
– Seek another type of investment that is not often in the limelight but consistently performs very well. Taking control of your finances may involve the oldest and simplest wealth creation strategy that is often overlooked.
7. Real Estate is the Best Alternative to the Financial Industry
Residential real estate is difficult to scale, in fact many have pointed out it is not investment grade(meaning it’s tough to place millions in houses quickly) due to the difficulty in managing a large portfolio of property. It’s for this reason that this investment class has not been corrupted by large players.
Direct ownership of income producing real estate is the best alternative to the trappings of the financial industry for a bunch of reasons:
– someone else is paying for most of your investment(the tenant)
– real estate by definition is REAL, it exists outside of computers and safely away from the imaginations of market manipulators
– REAL things retain value, that is why people also buy gold(plus it is easier to carry around than a house)
– prices of real estate rise with inflation, and faster if you buy in the right areas
The one thing I learned from the CSC that I actively use in my real estate business is this: the concept of Fiduciary Duty. This means only doing what is in the best interest of my client.
The way I ensure this happens is by structuring my loans or JV deals so my partner wins first, and wins big. I then get to participate in the win once all the initial capital is returned.
If things go badly, I am right there with my client working my butt off to make things right. But more importantly I mitigate risk every step of the way, minimizing any downside to such an extent, it almost doesn’t exist.
No other financial product or structure I have seen holds the advisor to such a high standard. For instance:
- MER are still paid if a fund loses value.
- Advisors who sell funds are either paid in a “front load” leaving less funds inside the investment. Otherwise, advisors are paid by trailing MER fees for as long as you own the fund. For these “back load” funds, if you try to leave early you will get penalty fees.
- Even fee-for-service advisors are paid right away, before you get any results!
After hundreds of hours of studying financial markets and after obtaining insider knowledge about our financial system, I could condense all I learned into the following statement.
The BEST instrument readily available to the middle class for building wealth is income producing real estate.
Until next time,