Today our main topic expands on a recent episode in which we talked about what constitutes good financial advice, and here we look at how to go about finding the kind of advice that you want and need. It is one thing to know what it is, but that does mean it is straightforward to locate an advisor or firm that provides it. After our opening salvo of some media recommendations and a review of the fascinating book on different ideas on leadership, called The Starfish and the Spider, we dive into a listener question about where to geographically weight your investments and the idea of underweighting the US equity of your portfolio. This leads to a much bigger consideration of the research, which we try to breeze through, and in sum seems to lead us back to the idea of the non-predictability of markets. For our main subject, we share an extensive list of questions to ask yourself before even beginning any conversations with advisors, and using your answers to determine the kind of advisor you need. From there, we get into the questions you can ask the advisor and firms you approach in order to make sure you find the best fit for your needs. We talk about credentials, investment philosophies, firm policies, and everything in between, and we will be posting this full list on our community platform for your reference too. Stay tuned for today's Talking Sense card, and Bad Advice of the Week too, and make sure to tune in for the great guests we have lined up in the coming weeks.

Key Points From This Episode:

• The positions that we are currently looking to fill here at the podcast! [0:05:48.2]

• This week's book of the week: unpacking The Starfish and the Spider and its lessons on leadership. [0:09:53.1]

• Looking at an interesting blog post about the power of systems over goals. [0:12:57.8]

• A listener question dealing with underweighting US equity in comparison to emerging markets. [0:14:40.5]

• Plotting trend lines and the inconsistent relationship between forecasts and outcomes. [0:23:02.4]

• Adjusting the standard errors, when using overlapping data samples. [0:27:48.3]

• Bootstrapped simulations for defining predictability and market timing. [0:29:20.2]

• Good financial advice and how to make sure you find it. [0:32:02.8]

• The three channels through which you can access advice; commission-based, asset-based fee advice, and fee-only. [0:33:30.2]

• The conflict of interest that arises with us delivering our thoughts on this topic. [0:36:28.8]

• Credentials and qualifications to look out for in Canada and abroad. [0:38:20.3]

• Starting with what you want from an advisor and departing from clearly defined goals.  [0:41:12.7] 

• Questions to ask yourself before selecting an advisor about your assets, self-management, and more. [0:45:22.8]

• The conversations to have with your chosen type of advisor; services provided, compensation, and more. [0:48:55.2]

• Getting to grips with the investment philosophy of an advisor and their firm. [0:54:50.1]

• This week's Talking Sense segment: choosing between a lump sum or installments. [0:57:28.2]

• Bad advice of the week and the seven reasons to own individually-managed portfolios of stocks. [0:58:14.6]

How to Select a Financial Advisor

Should you pay for financial advice?

Not everyone needs a financial advisor, but many people can benefit from working with one. We are careful not to extol the benefits of financial advice too much as DIY investing is a great solution for many people, but there are evidence-based benefits to professional financial advice. Good financial advice should focus on goal formation and quantification, asset allocation, insurance needs analysis, financial product allocation, quality financial decision-making, and tax awareness all while providing an external perspective. In some cases, financial advice can additionally offload the task of implementing the advice once it has been given.

Harlow et al. (2020) find that advised households add more than 15 percentage points of income replacement in retirement after controlling for potentially confounding variables like household-accumulated assets, household annual income, respondent age, marital status, higher education level, health status, and access to a workplace savings plan. 

In Decisive Chip and Dan Heath describe four villains of decision making: 

• Narrow framing, the tendency to define choices too narrowly or see them as binary when they are not; 

• Confirmation bias, the human tendency to form a quick belief and then seek out information that confirms it; 

• Short-term emotions which can get in the way of good decisions; 

• Overconfidence, the feeling that we know more about how the future will unfold than we actually do.

The four villains of decision making largely exist within what psychologists call the “inside view,” the view that stems from the information directly in front of us, including our own biases. One of the best ways to overcome the inside view is by reality testing your assumptions which in many cases, especially in complex areas like managing wealth, is best accomplished by consulting an expert. 

In Time Smart: How to reclaim your time and live a happier life, Ashley Whillans explains that people who value time more than money are likely to be happier, make more frequent social connections, have a stronger relationship with their spouse, and be more satisfied with their job. Valuing time over money is also prosocial - when we feel that we have more time we are better able to serve other people, which in turn increases our own happiness. Whillans argues that we are living in a time-poverty epidemic. Paying money to offload unpleasant tasks and increase time affluence can increase happiness.

Engelmann et al. (2009) find that when people get advice from an expert, they shut off the parts of their brain responsible for weighing options and opinions. Offloading the information processing needed to make financial decisions can decrease decision fatigue and increase the probability of taking action. This is particularly salient in financial decision-making where the information sources, opinions, facts, and options are objectively overwhelming. Iyengar & Lepper (2000) and Iyengar (2004) find that having more choices can be demotivating to making a decision and lead to less satisfaction with the decision once it has been made.

Survey-based studies from FP Canada and Fidelity Canada have found that advised investors show significant increases in financial and emotional well-being, confidence in tracking and meeting important goals, and confidence in their ability to deal with setbacks without making sacrifices. A study from Fidelity Australia found that 50% of Australians receiving financial advice had improved their mental health as a result of advice, while 38% reported an improvement in their family life.

The Misguided Beliefs of Financial Advisors

The case for financial advice is strong if you can find good financial advice, but the financial services industry has a bad reputation for good reason. There are conflicts of interest as documented by Cumming et al. (2015), but even outside of these conflicts many providers of financial advice simply do not know what they’re doing. This is particularly problematic given the evidence that investors shut off the information processing parts of their brain when they are being given advice by someone perceived as an expert. Linnainmaa et al. (2020) find within a large sample of Canadian financial advisors and their clients that advisors typically invest personally the same way that they advise their clients. If they were using low-cost index funds and sticking to a long-term plan this would be good news, but advisors in the study trade frequently, chase returns, prefer expensive and actively managed funds, and under-diversify. Advisors do not strategically hold expensive portfolios only to convince clients to do the same; they continue to do so after they leave the industry. Many financial advisors are good people plagued by misguided beliefs. This reality puts responsibility back on the consumer to perform appropriate due diligence before accepting financial advice.

Choosing an Advice Model (Questions to Ask Yourself)

Before making the decision to obtain financial advice, it is important to understand the ways that it can be obtained. In Canada, financial advice compensation models can be crudely categorized into three channels:

1. Commission-based advice

2. Time-based fee advice

3. Asset-based fee advice

Due to the inherent conflicts of interest in the commission-based model it should typically be avoided with one exception: buying insurance is almost always done through a commissioned salesperson. A good workaround is to get the advice on how much and what type of insurance is needed from an independent Certified Financial Planner before purchasing the product from an insurance agent.

Both time- and asset-based advisors should be able to help with things like defining and quantifying your goals, planning your cash flow, planning your retirement, optimizing for taxes, figuring out your asset allocation, analyzing your insurance needs, and optimizing the trade-offs of various financial decisions. An asset-based-fee advisor will tend to be what might be considered “full service”; they will give you good financial advice and help you make good decisions, but they will also take the action items needed to implement the advice and either do them or ensure that they are done by the appropriate professional.

This includes implementing your investment portfolio and adapting to changes. Changes in life circumstances can prompt a change in asset allocation or tax strategy, external events like a market decline may create opportunities for tax loss harvesting, and new securities or products that are better positioned to meet your objectives may become available. Even things as basic as making sure contributions to registered accounts are being optimized is something that an asset-based-fee advisor should do, and can do since they are implementing the overall strategy. Staying on top of things like this can, of course, be self-managed, but the point is that it’s not always as easy as setting it and forgetting it. Time-based advisors typically do not handle implementation, and in many cases they are not able to give specific investment recommendations because they are not licensed to do so.

Paying for time-based financial advice to set the course and get an outside perspective and then managing the implementation yourself is always going to be the most cost effective option if you ignore the time and mental overhead required to do it yourself. Even when these implicit costs are considered, for people with simple situations implementing a financial plan can be pretty easy. Similarly, if you are only looking for help on one important financial decision or for a second set of eyes but have your financial house in order, paying for time-based advice can make the most sense. As complexity and the value that you place on your time increase, the implicit cost of implementing financial advice can become high enough to make paying someone else to do it compelling.

One of the great things about time-based advice is that you pay the same amount regardless of your portfolio size. This makes advice accessible for people who have not accumulated the type of minimum portfolio size that an asset-based-fee firm would expect, or who have most of their assets in things like pensions or real estate that an advisor cannot manage.

To make a decision between time-based and asset-based fee advice, you can ask yourself the following questions:

• Do you have sufficient assets to work with a full-service fee-based wealth management firm? Most asset-based-fee firms have a minimum portfolio size. If you want advice but don’t have investments yet, this decision is easy. It depends on the firm, but it is typical to see $500,000 or greater as a minimum portfolio size. PWL Capital’s current minimum is $2,000,000.

• Do you want to manage your own investments and the other intricacies of your financial plan? Implementing a portfolio, financial plan, and tax strategy ends up being a lot of stuff to do and think about. Some people love doing it, others hate it, and many people are somewhere in between.

• Are you able to manage your own investments and the other intricacies of your financial plan? Wanting to do things yourself is one thing, but between time constraints and knowledge constraints, managing things yourself and doing a good job is often simply unrealistic. The overconfidence bias that humans suffer from makes this one particularly challenging to think about. 

• How do you value your time? Do you value time over money, or money over time? The more you value your time over money, the more willing you will be to pay to outsource tasks that you find unpleasant.

• How complex is your situation? If your situation is simple enough you may not have to spend much time managing it. As complexity increases, the time and knowledge required to do a great job tend to increase.

Choosing an Advisor (Questions to Ask a Potential Advisor)

After choosing the right fee model for your situation and needs, choosing the right firm and individual to work with is at least as important. It is common for people to find an advisor through a referral from a trusted friend or relative. This can be problematic if the inherited trust from the referral creates blind spots around the issues that should be evaluated prior to commencing a financial advice relationship. 

The following questions can help evaluate potential advisors. Keeping in mind that your brain will shut off some of its critical thinking once you have accepted someone as an expert, the upfront due diligence is extremely important.

• What services do you provide? This may seem like an obvious question, but not all advisors offer the full spectrum of financial advice. Ensuring that there is a fit between the services that you need and the services that a potential advisor provides is an important place to start.

• How are you compensated? Knowing how your advisor is paid builds the foundation for the whole relationship; asking this question will never be a bad idea. A time-based advisor should be able to tell you the cost of the services that you are hoping to get from them, and an asset-based advisor should be able to provide their fee schedule and confirm that they are paid by you, not by the products that they sell. 

• How do you manage conflicts of interest? There are always conflicts. For example, a time-based advisor makes more money if they sell more services, and an asset-based advisor makes more money if they manage more of your assets. Knowing what the potential conflicts of interest are and how they are addressed is critical.

• Are you a fiduciary? In Canada, Portfolios Managers will generally have a fiduciary duty under Canadian common law. Some firms, including PWL, take it a step further by being certified by CEFEX, the Center for Fiduciary Excellence. CEFEX is an independent global assessment and certification organization that helps determine the trustworthiness of investment fiduciaries. 

• What are your qualifications and experience? For a time-based advisor, their investment management credentials and even investment philosophy may be less important if your plan is to manage your own investments or have them managed elsewhere, but they should be qualified as a financial planner through the CFP or at least a qualified associate financial planner through the QAFP which is part of the path toward the CFP, and have experience working with clients in situations like yours. For an asset-based-fee advisor, seeking a Portfolio Manager in Canada will mean that they have either the CIM or CFA designation. In an asset-based-fee relationship it is not uncommon to have a financial planner and a portfolio manager working together to deliver the advice and service. In any case, there should be a CFP involved in the relationship whether they are the same person as the Portfolio Manager or not. 

• Do you work alone, or with a team? A lot of the work in a financial advice relationship revolves around the advisor gaining an understanding of your objectives, preferences, tendencies, and family dynamics in order to chart the best financial path within those constraints. Working with a team results in continuity of this mutual understanding if the advisor becomes unavailable temporarily or permanently.

• How do you describe your ideal client? Financial advice is a relationship-based engagement. The relationship is important since financial decisions are more about managing trade-offs than they are about finding the objectively optimal path. There needs to be a fit between the client and advisor for the relationship to work well. If the advisor’s description of an ideal client doesn’t sound like you, it may be a sign that the fit isn’t there.

• What is your investment philosophy, and how do you justify it? You can learn a lot about a potential advisor by their investment philosophy and how they justify it. A time-based advisor will not typically manage your investments, but they may offer guidance on asset allocation or referrals to investment managers, so it’s still worth asking even if they won’t be managing your investments. My answer to this question is that markets are pretty good at pricing assets, so the most sensible strategy is capturing the expected returns that the market has to offer rather than trying to beat them, and focusing on things that we have more control over like decision quality, fees, costs, and taxes. Strategies other than this, like trying to beat the market by security selection or market timing, or investing in alternative asset classes, are red flags.

• What is your firm’s investment philosophy? This is distinct from the advisor’s philosophy. An advisor who believes in low-cost index funds may work at a firm that has no unified philosophy, or maybe they’re surrounded by people picking individual stocks. It may make it harder for the advisor to stick with the philosophy if they are not surrounded and supported by like-minded people. Advisors need coaching and reassurance just like anybody else. If your advisor becomes unavailable, it may be reassuring to know that the rest of their firm has the same philosophy and approach.

• What tools do you use to assess my financial situation? Personal finance is complex and has a lot of moving interconnected parts. Having robust tools to model your financial situation is a necessity in making good financial decisions. You need a model to do things like quantify goals and manage trade-offs. 

• Will you push back on my decisions if you think they are contrary to my best interest? You would hope that an advisor will be there to push back on poor decisions that you intend to make, but it’s worth asking to confirm. This will set the tone for the future of the relationship.

Financial advice can be a powerful tool for increasing the quality of your financial decisions and your overall well-being. We hope that these questions make it easier for you to access the right type of financial advice from a competent professional. 

Read the Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making for Canadians. We're hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: So this is episode 162 and it could be the last one I'm recording here in my living room for those of you that watch on YouTube. A bit of a gong show here today. I was just telling Ben before we started recording, my garage door died after 18 years, got the garage door service person coming. I had carpenter people here last week, air conditioning service tomorrow. Poor Oscar, God love me. It's usually pretty good, but I know if the garage door guy comes, it'll be a complete gong show here. So he's gone to the neighbors. James will take care of the garage door guy.

Ben Felix: Have we only ever been doing videos since... Yeah, it's only been since pandemic life.

Cameron Passmore: Yeah.

Ben Felix: Wow.

Cameron Passmore: I think so.

Ben Felix: So people have never seen your cool office.

Cameron Passmore: Seen the cool office paint job. So Oscar will live on in the videos because Oscar is painted on the wall in my office. But what the problem is, we get the cameras with the autofocus, the autofocus messes up on the wall. The artworks we need to do some homework on that. Angelica is looking into that now.

Ben Felix: Huh. Maybe you could do a special video clip as part of our intro or something that shows your wall.

Cameron Passmore: Yeah, we'll see. And you're having fun with your house too, right here?

Ben Felix: Oh, yeah. I mean, just normal house stuff, but, yeah. I mean, it's the 1% home maintenance cost is a real thing.

Cameron Passmore: It's a real thing. It's no joke, right? It's just stuff that's completely sunk. Carpenter and treatment last week was like 400 bucks.

Ben Felix: Yeah.

Cameron Passmore: But they're eating away my deck. So you got to do it, right?

Ben Felix: Yeah.

Cameron Passmore: God knows what this garage door service is going to cost, but I guess when you advertise it over 18 years, it's not bad. But who knows. I thought my pool heater bombed out on the weekend, but luckily I had to reboot that and it was fine. That'd be another $1,000. So we dodged that bullet yesterday.

Ben Felix: Jeez, you're sounding more like a two percent maintenance cost over there.

Cameron Passmore: Well, it goes and ebbs, and ebbs and flows, right?

Ben Felix: Oh, if it ebbs and flows, it probably averages out to 1% then.

Cameron Passmore: So you had a neat hiking story you told me last week.

Ben Felix: Yeah. So I was out for a hike and coming back for my hike actually and I had my big heavy pack on, which of course I've talked about on the podcast. Someone came up behind me. I had my headphones in. I was actually listening to CFA Institute does a short podcast episode summarizing all of the articles in the financial analyst journal. So I was listening to that. Some interesting stuff in there.

Cameron Passmore: And as of course you would on a hike.

Ben Felix: Walking along. In like a fairly quiet, rural-ish area. Probably a 15-minute walk from my house. And I hear someone behind me, "You must be, Ben." Oh. And it-

Cameron Passmore: I must be.

Ben Felix: It turned out it was someone who listens to our podcast and they'd kind of figured based on my brief descriptions of where I'd moved to, which I've left intentionally vague. They kind of guessed that it might have been this area that they also live in. And then of course this tall person with a big pack ongoing for a walk, they figured it must've been me. So we chatted for a bit as I walked home, but it was pretty cool.

Cameron Passmore: That's pretty cool.

Ben Felix: Yep.

Cameron Passmore: And read it?

Ben Felix: Oh, yeah. I wanted to mention, as people know 3D printing is a hobby that I have, I hung a swing on my back porch for my kids. It's like this big circle swing. All the kids can go on. It's a pretty cool thing. But I hung it using eye bolts like just a lag bolt that has the circle thing where you can stick something onto it. So I hung it on there and I had just a carabiner on the eye bolt.

So the swing would work it was functional it's fine. But over time, actually, the wear happened in our old house because I had it set up the same way. It caused these like divots in the eye bolt, so the swing would do this clicking thing where it would skip between the divots as it was swinging. And it stressed the kids out because of like click, click, click. They thought it was going to fall.

So my solution was to 3D print this, insert that clipped in on either side of the eye bolt. So there's two separate pieces. I stuck a bearing in one of the pieces and then it clipped around the eye bolt and then my carabiner goes in the bearing. So now it's the silky smooth swing. I thought it was pretty cool so I posted it. I'm subscribed to a subreddit called Functional Prints or something like that. So I posted this in there because I thought people would think it was pretty cool. And I got almost 600 up votes when I posted it last week. We can link to my swing solution in the show notes.

Cameron Passmore: Wow, incredible. There's a community for everything.

Ben Felix: Yeah.

Cameron Passmore: Okay. Couple quick summer binging things. So Animal Kingdom season five is out for those who weren't aware that the show came out four weeks ago. I believe it's episode five this week, that's coming out. In Canada, we have to buy it on iTunes, I think. I don't think you could find it... Because you looked for it, right?

Ben Felix: Well, I saw your notes while I was looking at this yesterday and I got all excited because that's the one of the few shows that I've actually gotten sucked into in the last few years. We went to try and find it on Netflix. It wasn't there. So I Googled it. Apparently, it's available on Amazon Prime. So I checked there, but it wasn't there. I don't know.

Cameron Passmore: I don't know. Yeah, I think you have to pay for it. Each week, I get the note from iTunes saying it's ready to go. Another one we discovered while we were waiting for more Animal Kingdoms to come down is a show called StartUp. I'm kind of late to this one. It came out in 2016, but it's this crazy story. I don't want to give it away, but it's got gangs, and money launderers, and crooks, and crypto. In fact, it's so full of ideas, you almost think that algorithm created it, which I've heard some people talking about a lot of the content is algo or quasi-algo created. But it's really well done. The acting is good. It really pulls you in. So we're kind of hooked on that show right now.

We also want to talk about talent. So we're looking for, in our team a motion graphic designer with video editing skills. This is to produce the YouTube version of this podcast and also your common sense investing videos. So if you know someone, we're looking for an employee and preferably in Canada. But they can be remote.

Ben Felix: Yeah, in Canada but remote. And that's our first choice is to find an employee to join our team. Everybody else in our team. We'll see how the search goes, but definitely if you know anybody that would be good at that role anywhere in Canada, we'd be thrilled to have an introduction.

Cameron Passmore: I posted in my LinkedIn feed last week. I got people reaching out from all over the world. So there must be some sort of search function that happens looking for job postings because these aren't people I'm connected to. But dozens of them reached out.

Ben Felix: Yeah. I had the same experience.

Cameron Passmore: Anyways, and also if you're looking... We have lots of people reach out to you and I, just to talk careers in this space, financial planning wealth management space and we're looking regularly to hire people. So check out our job board on our website. I just love talking shops. So if you're an advisor, want to chat, reach out anytime. It's been amazing to talk to a number of advisors over the past couple years just based on the podcast. Upcoming guest next week is Dave Plecha who is the global head of fixed income at Dimensional Funds. Phenomenal interview.

Two weeks after that is Gordon Irlam, and then two weeks after that is the Canadian economist, Hersh Shefrin. He's currently a professor at Santa Clara university. So that'll be very good. Do you want to talk about Larry coming up?

Ben Felix: Yeah. So we've got a live community webinar just like we had with Wes Gray a while ago with Larry Swedroe on August 18th. So I know lots of people posted questions for Larry. I'll consolidate those into a list soon and post my final list up in the community so we can get final feedback and then it'll be a live discussion with Larry. And as everybody in the community knows from his participation in the community and otherwise, he's a phenomenal source of information. So that should be another good discussion.

Cameron Passmore: And very engaging. Very opinionated. He's a great guy. Yeah. I talked to Angelica last week. She let us know that the talking sense cards for the merchandise store are coming. They've been shipped. Not sure where they are, but they're coming. So let you know when they're in stock. We'll keep an eye on the community store for that and happy to ship them out.

I had a bunch of reviews in the past week. I don't know if we have time to go through all of them, but some really nice cam dad, JD is very grateful for the work we've done. He says that this is very good for DIY investors as well as financial services professionals. Lucas Streeter says, "Despite being a Canadian podcast, as a UK listener, there's a huge amount to be taken away every week." He really appreciates the guests.

GBJ111 says, "Fantastic. Incredible depth without losing clarity. I'm a statistician and love the rigorous data and analysis. I manage my own portfolio, but if I had to choose a financial advisor," very kind of him, he said he'd go with us. That was Josh Boston. He signed off. Navy Friar says, "I listen to about a half dozen financing investing weekly and find the Rational Reminder to be the most substantive in depth." Dollar-Dollars says, "Best investment podcast." I knew you'd laugh at that.

Ben Felix: Oh, yup.

Cameron Passmore: How else do you say that?

Ben Felix: There have been a ton of reviews, so it's crazy. And I think our total number of ratings and reviews on iTunes is at 642 when I checked this morning, which is pretty crazy.

Cameron Passmore: I think it jumped like 30 or 40 on the weekend.

Ben Felix: Yeah. So hopefully the reviews keep coming. We always appreciate them.

Cameron Passmore: And as always, connect with us on Instagram, Rational Reminder. Also, I'm on there on Peloton. I'm at CP313. I'm on Goodreads. We're all on twitter. And of course in the community, on the community board. Anything else to add?

Ben Felix: No, let's go ahead to the episode. Welcome to episode 162 of the Rational Reminder Podcast.

Cameron Passmore: I've got a great book of the week for you again. It's called The Starfish and the Spider: The Unstoppable Power of Leaderless Organizations by Ori Brafman and Rod A. Beckstrom. Have you heard of this book?

Ben Felix: Nope.

Cameron Passmore: So I was speaking to my friend Alex in San Jose, a few weeks ago and we're just talking business strategy and as listeners know, you and I have talked as a strategy over the past couple months. I mentioned to him the book, Playing to Win as well as The Infinite Game. So he suggested I check out The Starfish and the Spider as it's completely different from these two books. So instead of, as Simon Sinek says, setting the just cause and the mission, and then building up the strategy to achieve the mission, The Starfish and the Spider is all about how a decentralized leaderless organization can achieve great things.

The illustration of the Starfish is like the perfect illustration of this. So did you know that... I didn't know this. But a starfish in every tentacle has all the organs. So you can cut off any tentacle and you can grow back a whole new starfish. Whereas a spider, without the head, it just doesn't survive or it doesn't grow back legs. The book talks about many, many organizations that relate to starfish or at least have some starfish-like qualities. And the examples they give like Alcoholics Anonymous, I didn't realize it's a completely decentralized global organization that started in Akron, Ohio in 1935. Now, it's in 180 countries, 118,000 groups and over estimated 2 million members.

They don't really know because it's not essentially organized. Same thing with Wikipedia. Wikipedia started as free online encyclopedia written and maintained by this community of volunteer contributors. Completely open collaboration and now there's more than 56 million articles, 2 billion unique visits per month and 17 million edits per month. They talk in the book about how the internet has accelerated this starfish kind of thinking.

They give examples going back to Napster versus the music. Classic decentralization. Google same thing. User input drives Google searches. Anyways, the point is that, yes, organizations do need some leadership, but to have ability to decentralize parts of the business is very important to get creativity going. Then excellent service models. So I thought that was a good, good book.

Ben Felix: Given all of the thinking that you've done about the other books that you mentioned, about The Infinite Game and Playing to Win, does this change any of your thinking on strategy?

Cameron Passmore: It doesn't change my thinking. So I think what we've done well is we've hired great people kind of paint the mission, but then let them do great work. But the stuff that's been created in our team that we could not have imagined five years ago is to me unbelievable, right? So each group in our enterprise has that flexibility to create neat things and think independently. So it doesn't change it, but it certainly reinforces the benefit of having the ability to work independently and autonomously inside a team.

But this also links to the next topic which is listener community member, Tony Smiles sent us online a blog post from Scott Adams Who's the creator of Dilbert. So he was listening to you talking, where you and I talk about goal setting, how we're not big fans on goals and he says, "I too profoundly dislike goal settings and focuses on strategies and systems instead." So we found this blog post of Scott Adams. He shared it with us. It's called How to Fail at Almost Everything and Still Win Big. Kind of the story of my life.

So Scott Adams talks about how he uses systems instead of goals. For example, losing 10 pounds is a goal that most people can't maintain whereas learning to eat right is a system that substitutes knowledge for willpower. So Scott Adams explains that his problem with goals is that they can be limiting. He says, "Granted if you focus on one particular goal, your odds of achieving it are better than if you have no goal, but you also miss out on opportunities that might have been far better than your initial goal."

Just think about this podcast. I mean, you and I just sat down in front of two microphones three years ago. We had no idea what... We just did it, right? There's no overarching goal. We just frankly thought it'd be fun. But look at what it became. We never could have imagined how it all turned out. That's a pretty good example, right? So I thought that was a really neat post we can post that blog in the show notes as well.

Ben Felix: Does it relate to what we talked? We both talked about how we don't like setting goals particularly, but having habits and and doing things consistently, is that similar to what he's talking about?

Cameron Passmore: Yeah. And be prepared for what might happen, right?

Ben Felix: Mm-hmm (affirmative).

Cameron Passmore: If you look back five years ago, think of like... It's a good starfish example, right? Who knew what we would grow into? Just if you're decentralized, open to new ideas, try different things, you end up having these opportunities that can come up and you take advantage of them.

Ben Felix: Right. Cool. Listener question.

Cameron Passmore: Sure.

Ben Felix: So vantage in the community with them. Anyone that's in the community will recognize them as they're a pretty frequent poster. They posted a listener question, which by the way we had that listener question thread. And maybe, Angelica, when we post the episode or maybe each week or something like that, we can bump that topic to the top, because it's buried now but I would love to continue getting listener questions. We got a bunch of them when Angelica posted that topic, but it's kind of slowed down. So if we can keep getting new ones every week or whatever, that'd be awesome. So we still have a bunch like there are a bunch that I have not answered yet that I will answer over the next coming weeks, but I would like to continue having a source of new questions to answer.

Okay. Here's the question. "A relatively popular idea in the community seems to be that we should currently underweight US equity and overweight international and emerging markets equity. The reasons cited have to do with estimated future returns based on valuations/CAPE/forward CAPE. That's cyclically adjusted price earnings ratio. Is there scientific evidence that shows this strategy is likely to increase returns and/or what else does the evidence show? Is this strategy something that Ben would consider doing himself?" And they said, "PS, I re-read the transcript of the recent CAPE podcast." That's Do Expected Stock Returns wear a CAPE? I don't remember what episode that was, but didn't come across a direct answer.

So I was excited to answer this one because as people know, because we've talked about I think in a couple of episodes where we kind of talked through portions of the research, we've been doing unexpected returns, the most recent piece was this. I think last time we talked about Do Expected Stock Returns wear a CAPE? It was well like Vantage said in his question, it was not super conclusive and we weren't quite sure where we stood with it yet. I think if you believe that expected returns, that CAPE is a good predictor of expected returns, then it kind of follows from that, that you would want to or you would expect value from tactically allocating to the cheapest region. I think that's kind of implicit in believing that CAPE is a good predictor of future returns.

Cameron Passmore: Right.

Ben Felix: Not completely, and we'll talk about that in a second. But anyway, so this is one of the big things that I was trying to solve most recently on expected returns. I know I've kind of gone back and forth in this a few times. I think I'm finally at a place where we in our research team where we're all in agreement that not having CAPE in our expected return estimate is the right thing to do. And like I just described, I think it follows from that, that you wouldn't try to tactically allocate based on CAPE. Basically, it makes sense to think that every region has the same expected return, which may seem like an extreme statement for anybody that is used to using CAPE.

I mean, including us, we've been using CAPE in our expected return assumptions for a long time, with a 50% weight. But I think that's probably going to change in our next expected returns release. So that's where we stand on it. Would I consider doing this myself? I wouldn't. The evidence just doesn't support it. We'll talk through it and that is the evidence.

Now, I think from an economic logic perspective. It of course makes sense that expected returns change over time. From an economic logic perspective, they have to. Investors are going to demand higher expected returns when times are bad and they'll accept lower expected returns when times are good. If expected returns are higher, prices are going to be lower, all else equal. And CAPE is one way to measure that. It's debatable whether it's the best way, but it is definitely a way to measure how high prices are and it's measuring it relative to smooth earnings, which Robert Chiller thought was a a good way to do it.

I've seen counter arguments that you don't have to smooth the earnings, but whatever. It doesn't matter. It's a way to measure relative price. Another thing that this implies is that there's mean reversion in stock returns. That's another important piece there. There are two possible theoretical cases for mean reversion and stock returns. There's the behavioral case and that started with De Bont and Thaler's 1985 paper. And in that case, they're just overreacting to news, which causes prices to go above or below their fair value to which they will inevitably return.

So that's the behavioral case for predictability or main reversion. The hurting behavior of investors in the behavioral argument can push the effect even further which creates a feedback loop and that's the case for bubbles. And if it's a bubble, which FAMA would argue we can only know X post, but if it's a bubble, it will eventually pop. In the risk-based case, investors are responding rationally to economic circumstances by adjusting the required return for holding risky assets. So that's kind of my comment before.

Of course, expected returns change over time. If predictability is behavior based and this is an important little distinction, if it's behavior based then there's an opportunity for alpha. If prices are wrong and investors are over under-reacting, you can arbitrage that and earn excess risk adjusted returns. If it's risk-based, if predictable stock returns are risk-based, then you can earn higher expected returns by taking more risk. But unlike the behavioral case, it's not a risk-free profit. It's not alpha in that case. It's just you're taking more risk. That's the broad framework there to think about predictability.

Now, in the literature, so that's the economic logic, the theory. But then there's this question of are stock returns actually predictable? I hope people understand what I'm saying when I say predictable. It's this whole question of does CAPE... Well, I guess it's obvious. Does CAPE predict returns that implies or that's called in the literature predictability? So if CAPE predicts returns or if some other economic variable predicts returns then stock returns or bond returns are predictable.

Maybe that's obvious to say. I remember the first time that I read about predictability and stock returns from academics that I kind of knew and trusted. I was like, "What do they mean stock returns are predictable? That doesn't make any sense." Okay. So in the academic literature, John Cochran has a 2007 paper. Campbell and Thompson have a 2008 paper and they find in those papers that there is evidence of stock return predictability. And then Goyal and Welch have a 2008 paper, which is often cited as like the paper unpredictability.

Their finding was that predictability models would not have helped an investor with access only to available information at the time to profitably time the market. So that was a key. If you look at the full set of information, it can look like there is predictability, but if you look at only the information that would have been available to an investor at the time and then try and find evidence of predictability, it goes away.

Cliff Asness had a paper in 2017 where he looked at a similar bit of analysis and his explanation there is that observed predictability using the full data series has this inherent hindsight bias. But in real time, investors don't know what future valuations are going to be. So any notion of a higher low valuation in the historical data doesn't tell us much about whether current valuations are low or high relative to the future.

And then Dimson, Marsh, and Staunton in their annual returns yearbook 2013 edition, they looked at this with their proprietary global data set going back to 1900 and they explained it that these full data series observations of what seem like predictability can create something that feels like the gambler's fallacy or behaves like the gambler's fallacy which is the belief that deviations from expected behavior are likely to be followed by deviations in the opposite direction in the future, but they're saying that this is not actually the case.

They kind of describe it similar to what Asness says that if you look at the full ex-posts like we know this happened, observed trendline in stock returns. Mean reversion is going to seem blatantly obvious within that data series. It has to because we know the line goes this way. So if you stick a trend line in the middle, it looks predictable, but that seems obvious. You've got this...

Cameron Passmore: By definition.

Ben Felix: Right. So here's what happened over time. You got the wavy line of markets doing what they do over time. You stick a trend line through the middle and it-

Cameron Passmore: It has to be a mean reversion.

Ben Felix: Right. It has to be a mean reversion.

Cameron Passmore: Interesting.

Ben Felix: Yeah, isn't that interesting? So they're saying that this is a fallacy though because what's not obvious the mean reversion in that data series is obvious, but what's not obvious is that that trend line that same trend line is going to continue into the future. So if you plot from 1900 to 2013 like they did, and show the trend line, but then you plot from 1900 to 2021, if we could update their data then the trend line might not be the same trend line is the point that they're making. So what they did is looked in the global data from 1900 to 2012. And their concluding remarks are that for investors who do not have perfect foresight and who do not know the parameters of the model for the long distant future, there is no consistent relationship between forecasts and outcomes.

Moreover, for cases where there is a marginally significant relationship, this is fascinating. Okay. So they're saying there's no consistent relationship between forecasts. I think they were using dividends to price. There's no consistent relationship between forecasts and outcomes, so it's pretty noisy. So they do find, and they're looking at, I think 23 different countries they have in their sample or maybe 21 going back to 1900 without any interruptions.

For cases where there is a marginally significant relationship, roughly as many countries are significantly negative as are significantly positive. That piece I found to be crazy. Yes, there is some evidence of predictability in some countries, but it's negative in just as many cases as it's positive or roughly as many cases.

We see a lot of data on predictability in the US, but Dimson, Marsh, and Staunton we're looking at predictability globally also for a longer data series. So that one to me was quite powerful, especially that last piece that depending on where you look, depending on the country that you look at, there's some evidence of predictability, but in some cases it's negative just as much as it's positive. So it doesn't instill much confidence in predictability. Then they're doing the same thing. I don't know if I mentioned that. They're doing the same methodology where they're only making information that would have been available at the time to make each prediction.

So that's like if you have the full 100 and whatever they had, 13 years of data for the first 10 years. So if you're making a prediction in year 10, in their model, you only have the information that happened in those first 10 years in order to determine whether prices are high or low, and then they're pushing that forward every time as opposed to taking the full data series for the full 113 years and then ranking between high and low, which they also... I don't know if it was this paper they looked at, but Dimson, Marsh, and Staunton have looked at that. If you do that, if you take the full data series globally and rank things by cheap to expensive, then there's a clearly obvious relationship.

But if you don't do that, if you eliminate that hindsight bias then the predictability goes away. Asness did that in... I don't know if it's the paper that I have in my notes here that we'll link in the notes, but in a paper he did the same thing with US stocks where he did exactly what I just said. He ranks from high to low with the full data series and shows there's a clear relationship between valuation and future returns. And then you take the hindsight bias away. It doesn't go away completely in the US sample, but it becomes much less obvious

Cameron Passmore: Wow.

Ben Felix: Then Pastor and Stamba, when we talked to Lubos Pastor, he's got a 2012 paper where people may remember Lubos talking about this. An investor today does not know the long-term mean to which returns will revert. Investors don't know what the equity risk premium is and investors don't know the values of the parameters of the return generating process. So it's like, "Sure, stock return..." Well, I think Thomas said this too. "Stock returns are mean reverting, but we don't know what the mean is." So we've looked at this a lot doing our own analysis and we don't have a ton of data. We don't have as much as a Dimson, Marsh, and Staunton, but we did have some CAPE data going. It's a publicly available CAPE data going back. 1975, if I remember correctly.

So we did our own regressions and that kind of stuff on that. There's another paper by Bodach 2019 paper. They suggest an adjustment to the standard errors when you're looking at overlapping data samples. So in so much of the time series work that we do, in our field when we're looking at finance data series, we end up using overlapping samples. So you do like you a 10-year period within one month steps though.

So if you step forward one month, the majority of your data points overlap with the previous month. So they highlight in their paper why that's hugely problematic and why the T stats in so much of the regression work that gets done on financial data series are massively overstated. They offer an adjustment to make the T-stats more realistic based on the fact that the data are overlapping. So we did this for US stocks. The R-squared doesn't change so we still find the R-squared for Shiller CAPE on 10-year forward stock returns is 0.3, which is consistent with... It ranges from zero point, I don't know, three to four depending on the time period that you're looking at within US stocks.

But the T stat dropped to just above two, which is a big deal because before that it was some ridiculously high number that it made statistical significance to look obvious, with the adjustment it drops closer to the edge. So there's still some predictive power there, but not as obvious as when you have the tons of overlapping samples. The adjustment doesn't really work for the international data that we have because it's just not enough.

We have US data going back to 1871 or whatever through Schiller's website, but with the other data, it's just not enough to draw the same kind of conclusion. So R-squared 0.3. Take that as the truth. Take that as the predictive power. For bonds, actually it's a lot higher. That's worth mentioning using current yield on 10-year forward returns for intermediate treasuries. The R-squared is closer to 0.9, which is pretty interesting. But we're talking about stocks for this listener question. So take that as the truth. Take 0.3 as the R-squared. So CAPE is explaining 30% of the variation in future returns.

There's another paper and this one is not publicly available unfortunately. It's a dimensional paper from back when they weren't releasing their stuff publicly, which they now are, which is awesome. But it's by Davis 2015 paper and they used bootstrap simulations where they defined the predictability. So they defined the R-squared in the return generating process and then ran a bunch of simulations to see for varying levels of predictability how well would a market timing strategy perform. And at the R-squared of 0.3 level, which I think is probably generous to assume is the truth because as we just said, that's for the US, but Dimson, Marsh, and Staunton found it depends on where you look really. But at the 0.3 R-squared level, the investor varying their asset allocation each year based on the forecast would beat the buy and hold investor in only 18% of the simulations in that Davis paper.

They make the comment in that paper that that's under fixed and known return forecasting parameters in their model, which is obviously not the way that the real world works. So our return is predictable maybe. We're going to ask John Cochran that question when he's a guest on the podcast in the next couple of months and he's written the paper arguing in favor of predictability. So I'm thrilled seriously, thrilled to ask him that question. People may laugh at that, but I'm very excited.

So are they predictable? Maybe they are. Are they predictable in a way that would allow you to time the market or time your exposure to different countries? I don't think so. I don't even think like I mentioned when I kick this topic off, I don't even think that they're predictable in a way that we should be adjusting our expectations year to year or semiannually like we've been doing based on CAPE because the relationship is just not strong enough. And even if the relationship is as strong as it has been in the US that's not strong enough to add value to outcomes.

Cameron Passmore: Pretty good answer, I'd suggest.

Ben Felix: I hope so.

Cameron Passmore: It's almost as beefy as the main topic.

Ben Felix: Yep.

Cameron Passmore: That's a good answer. Well, hopefully the crowd appreciates it.

Ben Felix: Yep. It'll be interesting to see how people respond in the community because like Vantage said in in the question, there are a lot of discussions about... I even saw one recently where people are talking about really underweighting the US because the CAPE is so low and and completely getting away from geographic cap weights. Be interesting to see how everybody responds. And we'll link all the papers that I mentioned so people can go and do their own research as they all love to do.

Cameron Passmore: Okay. So where did the main topic for this week come from?

Ben Felix: Main topic came from when I did the video and we did the topic on the podcast on what is good financial advice. A fair amount enough that made me think it was worth covering of people asked, "Okay. So that's what good financial advice is fun. But how do you find someone to give that to you. Where do you get it?

Cameron Passmore: Right.

Ben Felix: And as people remember in that video, we said that good financial advice as we called it, should focus on... Well, it shouldn't focus on how to allocate to the best managers or pick the right stocks at the right time, and it should focus on goal formation quantification, asset allocation, insurance needs analysis, financial product allocation, general financial decision-making and tax awareness all while providing an external perspective. That was kind of our conclusion there.

Cameron Passmore: Pretty good list.

Ben Felix: I thought that was pretty good. So I thought about this a lot and I thought about it a lot since we covered that topic. I tried to break it down into two sets of questions. One set of questions that people can ask themselves and one set of questions that people can ask the potential advisor. I've got a lot of notes on financial services industry in Canada, but I might actually skip over them. I'm going to do this as a YouTube video too. I think I might just gloss over my overview of financial services. What do you think?

Cameron Passmore: Go for it.

Ben Felix: Because we did spend a lot of time on CAPE. So basically, I'm not skipping over because it's specific to Canada because I think it is universal. I think in most developed country markets, it'll look somewhat similar. At least in the US it looks pretty similar. In Australia, I believe it is pretty similar, same as the UK. There are really three primary channels and there's overlap and there's other offerings and all that kind of stuff, but there are really three primary channels where you can access financial advice.

One of the channels is commission based advice where you're buying a product from someone who's selling it to you. One channel is asset based fee advice which is what we do where the advisor is not being compensated by commissions, the client is paying them directly, but it's based on a percentage of the portfolio. And then the last model is fee only. It's sometimes called hourly fee advice where you're paying an amount specifically for the advice that you're receiving and it's completely unrelated to the size of the portfolio and you're not getting in that case. I think this is an important distinction. You're not getting the implementation.

So you're going to get a financial plan. You're going to pay hourly for it or you're going to get coaching on a financial decision or feedback on your portfolio or whatever, but you're not going to get implementation whereas with a service like what we provide, we're doing the analysis giving the advice, coaching on the decisions and then either hand-holding or doing the execution of all of that stuff, plus coordinating with all the external experts and all that kind of stuff.

So commission-based advice, asset-based fee advice, and what I would call time based advice where you're paying for time, but you're not necessarily typically not getting the execution piece. I think one other contextual piece that's important is the registration. So how is the person registered or licensed to give financial advice? In the hourly advice area, in many or most cases, at least from what I've seen in Canada, they will not be licensed to sell any product because that's not what they do. They don't sell products. So that just makes sense.

Other than that though, so if someone is giving advice on insurance products or selling insurance products, mutual funds, stocks, bonds, derivatives all that kind of stuff, they will be licensed. And that registration piece can matter a lot. In Canada, there's one type of registration, which is the registration that we have portfolio manager. And under Canadian common law, it's generally understood that portfolio managers because they have discretionary authority over client accounts, they have a fiduciary duty. They're legally required to act in the best interest of their clients and that's not true.

There's no statutory fiduciary duty for other registration categories and the common law fiduciary duty is much less obvious for other types of registration. In the states, there's something similar where RIAs have a fiduciary duty. Other types of registrants don't like a stock broker doesn't. So I don't know about other markets, but that fiduciary piece ends up being important, which should seem obvious. We're talking about somebody that you're going to get financial advice from. You would hope that they're required legally to act in your best interest, but it actually ends up being almost an edge case where that's true, which is kind of too bad.

I do want to back up for a second. My intention was to give a bit of a disclaimer before jumping into this topic just knowing that we are portfolio managers, which I just said is a good thing and I believe that's true. We do have a conflict of interest delivering this topic. I guess we do and we could in many topics that we talk about. This one just feels especially close to home. So it is in our best interest to make what we do in the service that we provide sound good. But I am going to try and provide information that's not biased.

Now, with that being said, I do believe that what we do is one of the best ways to access financial advice and that our firm is one of the best at delivering financial advice in Canada. And I'm not just saying that because I work for PWL. The causality is actually the other way. I worked for PWL and sought this company out because I think that that's what even back eight years ago before I worked for PWL, I looked up to this company as doing the best job and using index funds and all that good stuff. Anyway, I wanted to get that-

Cameron Passmore: And the time-based model is great for some people. It's what's best for you and your situation, which is one of your points in all this.

Ben Felix: That's exactly what I wanted to try and get across with these questions that I've come up with. Oh, I said I was going to try and cut this short. I ended up touching on a lot of the points that I wanted to anyway, but I think I shortened it a bit. The other thing that I wanted to mention was... So we talked about type fee models. We talked a little bit about registration and portfolio manager versus an insurance sales person, a mutual fund sales person and what that means from a legal perspective in terms of fiduciary duty.

The other one I wanted to touch on is credentials. I think, if you're looking for financial advice in terms of credentials, the CFP... I mean, for financial advice, the CFP really is the gold standard for financial advice broadly speaking because it provides a country specific, which is important. CFA for example is a global designation. The CFA exam is the same whether you live in Canada or India. The CFP is administered locally.

In Canada, we have FB Canada. In the States, I think it's called the CFP Board. So the content is specific to the country. So that means tax, product, all that kind of stuff is country specific which I think is important. CFP is also... It's not a small undertaking and I think it's actually gotten harder since I did it at least in terms of the time that it takes to complete all the requirements. We've got people on our team that are going through the courses now and it's no joke.

There's an academic component. There are tests. There's a work experience requirement. And if someone is a CFP, they have standards of professional responsibility and a code of ethics that they're bound by. So I think in terms of credentials, CFP is big. We talked about these three different fee models. If you're looking to have your investments managed by somebody and they're going to be a fiduciary as I've suggested, then they're going to be a portfolio manager.

And if they're going to be a portfolio manager in Canada, they're going to have either the charter financial analyst or the chartered investment manager designation. So the CFA or the CIM. That's a requirement in Canada to be a discretionary portfolio manager. So you're going to get one of those if you're getting a portfolio manager. Like I said CFP is a gold standard for financial advice. CFA is just the gold standard for finance, which also means that it's broader than it needs to be for the specific purpose of giving financial advice. I'm very happy that I completed all of that coursework. Would I expect anybody that we're going to put in front of a client for example to have completed the CFA? No, not even close. It's massive overkill for most of the things that we spend our time talking to clients about it.

Cameron Passmore: Yeah. Having said that, we have a bunch of people on our team that are actually going through the CFA course of study now.

Ben Felix: Well, I think that we've cultivated a culture of striving for excellence in education, which is something that personally I do think that's important and maybe that's where some of that culture came from. I don't know. But yes, we do have several people on our team who are pursuing the CFA, which is fantastic. I mean, listen, given the choice, all else equal, between if it's me, hiring somebody that's done all the CFA coursework and maybe they've even got their work experience. If I'm making the choice between hiring someone who does not have it, all else equal maybe they both have the CFP and the same experience in education whatever. And I'm probably going to take the person to the CFA. Maybe they demand a higher salary though. So all else probably isn't equal, but anyway, I do think there's some value there.

Okay. I hope that didn't come across as too disorganized. I was trying to give some context. So with that context, I think what you said, Cameron, I completely agree with, when you're looking for a financial advisor, the first thing that you need to know is what it is that you want from them. Both time and asset based advisors can help with stuff like defining and quantifying your goals. All the stuff that we said is good financial advice.

Ben Felix: Cash flow planning, retirement planning, tax optimization, insurance needs, asset allocation. Financial planning as defined in the financial planning curriculum. All that stuff is something that you're going to get that you should get from both an asset based and a time-based advisor. With an asset based advisor, the big distinction, and I alluded to this earlier, that's more of what I would call a full service experience. They're going to give the advice and they're going to do it or make sure that it gets done and coordinate all the professionals that need to be coordinated to make it all happen.

They're going to implement the portfolio because they're doing the implementation. If your life circumstances has changed and that should prompt to change an asset allocation or tax strategy, or if the market changes and that prompts a change in the tax strategy like tax loss harvesting. In the rare case, wouldn't that makes sense as we talked about in a recent episode?

Cameron Passmore: I was waiting for that qualifier.

Ben Felix: Or new securities even. I mean, when the Ivantis products came out, we spent a bunch of time looking very closely at them and other products could become available in the future. So looking at all that stuff, that's all part of implementation. It's not a one-time, "Oh, I implemented my plan. I'm done." This stuff is ongoing. We spend all of our time doing that for people. So I can tell you with certainty that there's a lot of stuff that happens to make all these things flow smoothly. Even stuff like maxing out registered accounts, which is personally something that I do and it's annoying to know have you contributed the right amount to each kid's RESP for the last two years to catch up on grants and all that stuff. But again, in the case of the asset-based advisor because they're doing the implementation that's something that they can be on top of, because they're right there.

Cameron Passmore: Yep.

Ben Felix: Now, of course that's all stuff that you can do yourself, but the point I'm trying to make is that it's not always that easy and with a time-based advisor, that's what you're giving up because they're not going to do all of that stuff for you. And even a little bit beyond that, they're typically not able to give specific investment recommendations because they're typically, and I'm saying typically because a lot of this is messier than that, but in most cases that I've seen anyway, the hourly fee advisors are not licensed to give specific investment advice.

So paying for the time-based financial advice to set the course and get the outside perspective and get all the good financial advice that I talked about and then manage the implementation yourself, that's going to be the most cost effective option. There's no question there especially... Well, maybe even only, if you ignore the time and mental overhead costs that are required to do yourself. And I'm not bashing do-it-yourself investing by any means, I just think those things are important to think about. People with simple situations, maybe those implicit costs are lower.

I also think that if you're only looking for help on a specific financial decision or if you just want a second set of eyes, but everything else is rolling smoothly in your financial planning on a do-it-yourself basis, then of course paying for time-based advice in those cases makes the most sense. I do think that as the complexity of the situation and the value that you place in your own time increase, that the implicit cost of implementing financial advice yourself can become high enough that it makes sense to pay for it.

Now, one of the other cases where time-based advice is the obvious answer is if you don't have sufficient assets to start a relationship with a firm like PWL. Firms like us tend to have minimums that make us unfortunately inaccessible to a lot of people and that's not always because people don't have sufficient assets accumulated. If people have most of their assets in pensions or in other assets like real estate then time-based advice is just... That's what you would have to do.

Cameron Passmore: Precisely.

Ben Felix: Okay. So that was a whole bunch of background information. And again, I hope it didn't come across as too disorganized. I had very organized notes, but I was trying to trim them down as I was talking there. So the questions. I'll talk through the questions and my commentary on them. So the questions to ask yourself in selecting a financial advisor, do you have sufficient assets to work with a full-service fee-based wealth management firm? If you don't have the minimum then like we just said, it makes the decision pretty easy. Do you want to manage your own investments and the other intricacies of your financial plan?

Again, a lot of moving parts, a lot of different things needing to happen at different times especially as complexity increases like the amount of tracking of stuff that needs to happen at specific times in accounts to make sure the tax strategy for example works is endless. So if you want to do that-

Cameron Passmore: Some people really do enjoy it though.

Ben Felix: And that's one of my comments. Some people love it. And if you love it, hey, the cost of doing it yourself is low if you get joy out of it. I think you might be different. Different from me anyway. I don't know if I would say that I get joy out of implementing stuff like that as much as I enjoy personal finance. But hey, to each their own. Are you able to manage your own investments and the other intricacies of your financial plan? Distinct from wanting to do it, I think that there's a time constraints. Again, using myself as an example.

Even if I loved doing all of this stuff and wanted to do it, it's not realistic for me. Well, in my current situation, it is. If I had more complex stuff to track and manage, the time would kill me even if I wanted to do it, which I wouldn't. And then of course the overconfidence bias that humans suffer from make that question of can you do it? Pretty hard to think about. The next question is how do you value your time.

Again, I like paying for services to get time. I think if people love this stuff like we just mentioned, then maybe the time cost is low because you're getting joy out of the process of doing it and that may be true with a bit of a selection bias for people that are listening to the podcast right now because they spend an hour or more every week learning about this stuff. But I think the more that you value ownership of your time, the more willing... This is universally true. Not just for finance, personal finance. The more you value your time, the more you're willing to outsource tasks that you find unpleasant, with unpleasant being the key there.

The next question is how complex is your situation. If your situation is simple then even if you don't enjoy it, managing yourself can be a possibility. But as complexity increases both the time and the knowledge required to really do a good job increase. So those are the questions that you ask yourself to figure out if you should be going with an hourly fee, advice arrangement or a fee based full service wealth management arrangement.

You may notice that I excluded the third category of advice altogether, which is commission based advice. I don't think anybody should go buy product on a commission basis as a substitute for financial advice. The one tricky area there is insurance. In Canada, you're almost always going to pay a commission to buy life insurance. That's the only way it can be sold in Canada for the most part. I still think you can get advice though if you have like... For our clients for example, we will give advice on the amount and type of insurance, and then it will be purchased from an agent but within those specific parameters.

For someone who's not our client, maybe that's the kind of thing that you go to a fee only hourly advisor to get your insurance needs analyzed, and then you go and buy the product. So that's my work around for that. Other than that, I just don't see how you can have an advice-based relationship when the incentives are all focused on product sales.

Okay. So given a fee model, you've decided which direction you want to go asset-based fee or time-based fee? Given that, these are the questions that you would ask to the advisor as you're evaluating them. Maybe there are a couple candidates or whatever. You're just trying to make the final decision. So the questions for the advisor, what services do you provide and that's maybe an obvious question, but the services aren't always obvious.

So I think that's question number one, and you got to make sure that the services that they offer line up with what you want. How are you compensated? I mean, we've already eliminated commission-based advisors, but you still ask the question. You still ask because you need to know explicitly how compensation works in the relationship. With the time-based advisor, they'll be able to tell you the cost of the services that you want to get. With an asset-based advisor, they'll be able to tell you their fee schedule and confirm that they're being paid by you and not by products that they're selling.

The next question how do you manage conflicts of interest? There will be conflicts of interest in any relationship and just knowing how they're going to be disclosed and addressed, I think is important.So it's an important question to ask. Are you a fiduciary? Like I mentioned before in Canada, portfolio managers will generally have a fiduciary duty under Canadian common law. PWL has taken another step where we are certified by CFX, which is the Center for Fiduciary Excellence, which is an independent global assessment and certification organization that helps to determine the trustworthiness of investment fiduciaries. So we've been independently audited and verified as acting as a fiduciary. So we think that's very important. I think there are templates for fiduciary pledges that you can take probably to a fee based advisor to have them sign. There are other ways to work around that.

Next question, what are your qualifications and experience? This one's interesting. For a time-based advisor, you might not care as much about investment expertise or credentials. Now, someone who's done the CFP, which if you're dealing with a time-based financial planner, you would hope that they're a CFP or at least on their way to being a CFP which is currently called the QAFP, Qualified Associate Financial Planner. So some kind of certification. Financial planning is important and through that there is an investment management component.

But I don't think you need a CFA if you're going to pay hourly for financial planning work. That's probably extra, extra overkill. In that case, for the asset-based fee advisor, when you're looking for qualifications, that's where ideally they're going to be a portfolio manager. So you're getting that common law fiduciary duty and then implicitly they'll be either a CIM or a CFA. Which one? I don't think really makes a big difference.

Even with the portfolio manager though, I would hope that either they have a CFP like I have both or they're working with a CFP on their team. I think the knowledge sets within what you learn in the CFP or the baseline knowledge you'd expect some of the CFP to have versus CIM and CFA. They're different and having both is important.

Next question, do you work alone or with a team? Again, I think this is important where if you're working with an individual. That can be fine, but in terms of continuity, which I think is important because so much of financial advice is based on gaining and understanding that the person giving advice gaining an understanding of the person receiving advice, because so much of financial decision making is about managing trade-offs given your specific objectives and preferences and tendencies, and family dynamics, and all that kind of soft stuff, and the value of having somebody that knows all of that is a huge portion of the value of financial advice, generally speaking.

So if you're working with an individual and something happens to them or they change careers or whatever, you lose that. You lose all of the work that was done on that aspect of the relationship whereas when there's a team involved, there can be more continuity and should be more continuity especially if the relationships are being done properly. Using us as an example, we have at least two people involved in every single relationship where that deep understanding is not just in one person's head.

The next question, how do you describe your ideal client? So like I just mentioned, this is a relationship based engagement. And a lot of financial advice is based on managing trade-offs not based on quantifying the optimal path, although that can be part of it, but it ultimately comes down to managing trade-offs, which often ends up being anchored in things like values as opposed to numbers. Values could be numbers, but that's not what I meant. You know the kind of values I was talking about.

Cameron Passmore: We got what you meant. Don't worry.

Ben Felix: So there's got to be a fit, and I think that to understand what the potential advisor's ideal client is helps you, the person deciding if you should work with them understand if there's going to be a good fit. If a potential advisor describes their ideal clients and it's nothing like you, maybe not a good relationship to proceed with.

Now, this next one's a big one and I think this is something that you can ask both a time-based and an asset-based fee advisor. What is your investment philosophy and how do you justify it? With a time-based advisor, if they're not giving investment advice, which in a lot of cases is true, maybe this isn't fair to ask. I don't know. I would still ask. To me, this one's just so fundamental and I don't know. I guess maybe I'm overly passionate about it, but it's evidence-based thinking and the evidence on investing is pretty strong.

So if somebody said, "I pick dividend stocks or whatever," personally, there'll be a red flag. I think that it's probably fair to say there should be a red flag. For anyone, I guess with the exception of if you yourself pick dividend stocks, then that would be maybe a great fit.

Cameron Passmore: Exactly.

Ben Felix: The way that I would answer that question is that markets are pretty good at pricing assets so the most sensible investment strategy is capturing the expected returns of the market rather than trying to outperform them and focusing on things that we have more control over like decision quality, fees, costs, and taxes. I think any major deviation from that answer like saying that I believe that we can beat the market or I believe we can pick the best stocks or I believe we should invest in hedge funds. I think those are all pretty significant red flags in assessing an advisor.

Cameron Passmore: And that's the way the majority of the industry is.

Ben Felix: Right. That's the truth. The next one is a bit nuanced. What is your firm's investment philosophy? Now, that's distinct from what is your investment philosophy. It can happen and actually in most cases it does happen that the individual's investment philosophy will not be the same as their firms. Now, in some cases that's because the firm doesn't have an investment philosophy. At PWL, we have an investment philosophy. At one of the big banks wealth management arms, they don't have a philosophy. They have a platform. And any advisor, not any advisor, but advisors that are on the platform are able to perform as they wish.

They're able to structure portfolios and give investment advice as they see fit for their clients, which is... I mean, that's okay. They provide a platform for advisors to do what they think is best for the clients, and that's fine. I think there are big benefits though to having a firm with a unified philosophy. For example, if your advisor becomes unavailable for some reason, I would think that there's at least a psychological benefit, probably a real benefit to having other people in backup positions across the firm with the same philosophy as opposed to getting passed off to somebody else who may have a completely different approach.

What tools do you use to assess my financial situation?" Personal finance is, it's past a spreadsheet probably, a lot of moving parts. A lot of tax details that are changing all the time. So having good tools to model financial situations and stress test them using things like Monte Carlo, I think is important. So it's a question worth asking.

Then the last one. Will you push back on my decisions if you think they're contrary to my best interest? I think that's a big one and it's definitely worth asking a potential advisor. You would hope that they would do that and many people would probably say that they would. I think asking that question probably sets the tone for the relationship though.

Cameron Passmore: It's a pretty good list.

Ben Felix: I think so and we'll post all those questions in the community and maybe on a blog post too, just so that people can access that easily and take it to their next meeting with a prospective advisor.

Cameron Passmore: Okay. So shall we go into talking sense? Maybe we'll just do one card this week-

Ben Felix: Sounds good.

Cameron Passmore: ... in the spirit of time. All right we've not seen this card. If you win a big monetary prize, you can often choose whether to take all the money right away or to get it in smaller pieces over 30 years, which would you choose? Well, I guess you have to do the math and see what the discounted interest rate they're using on the choices. So notwithstanding that, I would probably be inclined to take it right away. Best of myself, my own portfolio, my own preferences. And you?

Ben Felix: Well, I'm probably going to take it all and put it in small cap value. It's unlikely that the-

Cameron Passmore: The Larry Swedroe portfolio. Partial Larry.

Ben Felix: That's it.

Cameron Passmore: That's it? There we go. Small cap value all the way. Okay. Let's keep going here. Bad advice of the week. So it comes from a tweet that I actually saw that comes from a really high profile Canadian investment manager who actually is still a regular guest on Canada's national business television. I think it's called Bloomberg TV now. Anyway so the tweet read this. It continues to surprise me that you can get such great dividend yields in the boring Canadian utilities, pipelines, telcos, and banks. With GICs paying less than 1%, why wouldn't you take a 4 or 4% tax preferred dividend on BCE, Enbridge or TD bank? This gives me away.

Ben Felix: Comparable, right? They're both guaranteed, right? Dividends and...

Cameron Passmore: Of course.

Ben Felix: Okay. Just making sure.

Cameron Passmore: Just a lot that is what I infer from. Anyways, so that's probably good enough for bad advice of the wee, but I decided to go to the website, looked at their June newsletter which had seven reasons to own individually managed portfolios, obviously, of stocks. So let's go through the seven points quickly. Number one reason to invest in your own individually managed portfolio. Index funds combine the good, the bad, and the ugly. That's like a greatest hits tour of why not to index. It points out that you'll own every loser, the market goes down sharply as it did last spring. Your funds go down with it. I couldn't find their data to see if they didn't go down in March of 2020, but I couldn't find any evidence of that.

Number two, funds may not be as diversified as you think or as you want. So of course they pulled out the old Nortel was a third of the index back in '99, 2000. It's not the case right now. Right now, the current top five holdings in the TSX index are Shopify 9%, Royal Bank 8%, TD 7%, Brookfield 4, and Enbridge 4%. Plus index is so much more than only one index. You have a global diversity full of index funds. You have 10,000 shares. If you're well diversified, it wasn't an issue back in '99 or 2000.

Number three reason. What do you own and why do you own it? So yes, you're in the dark. I agree they'd make the point that you're in the dark of what the fund owns. That is true. But do you really need to care? If you believe the markets work, that you said earlier. It doesn't really matter.

Number four, you have no control over your tax situation. And they say if your portfolio is made up of only registered accounts such as RRSPs and TFSA taxes are an issue. However, for other accounts, taxes can have a major impact on your returns. We know lots of people had an unpleasant February surprise when the tax slips arrived from mutual fund managers. Yes, that's true for active funds, but there's very little tax friction like that in index funds.

Number five, depending on the product, liquidity can be problematic or occasionally impossible. So they talk about the story of transferring in an account to their firm that held illiquid investments. Well, sure, if you hold a lot liquid investments, but ETFs are highly liquid, so I don't understand.

Number six, who is paying attention to your needs. Investing in mutual funds and ETFs is easy. So easy in fact that clients of large banks and mutual fund companies may find that nobody is paying attention to their holdings. Once the initial asset allocation has taken place, it's often a case of fire and forget. A fundamental principle, a good portfolio management is to monitor investments carefully, reading quarterly reports and listening to company conference calls, all in the service of weeding out poor performers.

The argument though that they're making is that they're doing so much work and they are bright people, but that is also one of the reasons why indexing makes so much sense. Are so many people doing this? But that's what causes the information to show up instead of prices.

Ben Felix: What I said earlier, if you do what he's saying, and then believe that markets work and let the index funds do their thing without reading the quarterly report. Not that you'd be doing that for the index fund anyway, but it lets you focus on the other stuff. It lets you focus on the stuff that you can control as opposed to stuff that you can't like the tax efficiency trying to minimize costs and making good decisions. But if you're spending all of your time focused on which securities we should do and what should the next iteration of the portfolio look like, and which companies management team is not going to deliver results next quarter, then you don't have time to focus on the other stuff.

Cameron Passmore: Yeah, and holders of index products have no way of avoiding the inevitable stinkers that detract from portfolio return. How many times we talked about skewness and how much return comes from so few stocks? Isn't it like 90% of them are stinkers over a long period of time? More than that.

Ben Felix: Yeah. You're better off holding the stinkers than risking the chance of missing the winners because of the skewness in stock returns.

Cameron Passmore: Number seven, the last one. Foreign holdings carry an additional level of risk, fluctuating currencies.

Ben Felix: Wait. What does that have to do with index funds?

Cameron Passmore: Hey, I'm just telling you. In summation, mutual funds and ETFs are a great solution for some investors. Chiefly, those who has invested funds are not large enough to allow adequate diversification, those who choose not to engage professional managers. For all others, we think there are real advantages to the individually managed portfolio. Our results of the last 23 years demonstrate the truth of the statement. I'm guessing it could be survivorship bias and that. I don't know if they've done regression to find out the explanatory reasons for their outperformance or if the outperformance is true if you did do that regression, I don't know.

Ben Felix: For the last 23 years in Canada, it could be a small cap value story.

Cameron Passmore: It could be.

Ben Felix: There's a premium over the last 23 years. Not over the last 18, but over the last 23, there was.

Cameron Passmore: Can you imagine why have a GIC less than 1% when you can buy a dividend?

Ben Felix: I can't imagine saying that, having that conversation with a client if someone said, "I've got this expense coming up in six months. What should I do?" I probably wouldn't even say a GIC, but if I said the alternatives word, "Well, we could do a GIC, or we could buy some shares of Bell." I don't know.

Cameron Passmore: All right. Anything else?

Ben Felix: No, I think that's all for today.

Cameron Passmore: As always, thanks for listening.

Book From Today’s Episode:

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Links From Today’s Episode:

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Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore

'How to Fail at Almost Everything and Still Win Big' — https://fs.blog/2013/12/scott-adams-fail-at-everything/

'Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?' — https://www.jstor.org/stable/40056860

'The Dog That Did Not Bark: A Defense of Return Predictability' — https://academic.oup.com/rfs/article-abstract/21/4/1533/1567100

'A Comprehensive Look at The Empirical Performance of Equity Premium Prediction' — https://academic.oup.com/rfs/article-abstract/21/4/1455/1565737

'Market Timing: Sin a Little' — https://www.aqr.com/Insights/Research/White-Papers/Market-Timing-Sin-a-Little

'Are Stocks Really Less Volatile in the Long Run?' — https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.2012.01722.x

'Long-Horizon Predictability: A Cautionary Tale' — https://www.tandfonline.com/doi/full/10.1080/0015198X.2018.1547056

Benjamin's Swing Solution on Reddit — https://www.reddit.com/r/functionalprint/comments/ourj1t/turned_a_standard_eyebolt_into_the_smoothest/