Canada’s new financial planning guidelines: what you should know

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By Julie Cazzin with John De Goey

Q: My wife Jane and I are in our 60s and have always taken an active part in drawing up our financial plan and investing our retirement money. I just heard that the main financial planning associations in Canada have released new planning assumptions and guidelines. What are they and what do I need to know about them? — Bernard

FP Answers: You are correct, Bernard. As of May 1, the updated guidelines regarding financial planning went into effect. They generally change relatively little from year to year, but they are nonetheless useful in making modest adjustments for people who make long-term (10-plus years) plans.

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There are two main problems with these guidelines.

The first is that most people do not use them when writing financial plans (the plans are supposed to govern only certified financial planner (CFP) registrants). Many people will instruct a planner to assume a particular rate of return when drawing up projections and planners are too often willing to accommodate whatever assumption has been put forward, irrespective of how reasonable it is.

There are many people out there who honestly think it is reasonable to expect a double-digit return over a multi-decade time horizon for a balanced portfolio. That expectation is utterly unreasonable.

The second is that those who do use them frequently do so improperly. In simple terms, CFPs are instructed to project expected equity returns in developed stock markets of between six per cent and seven per cent. Similarly, the expected return in the bond markets should be between three per cent and four per cent.

As such, an investor with a balanced portfolio might expect something between those ranges depending on their overall asset allocation. A 50/50 mix between stocks and bonds should be projected to return about five per cent. Even a relatively aggressive portfolio with a 75/25 split should only be projected to return about 5.75 per cent.

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Again, most people, including many planners, ignore these guidelines and use higher numbers. To make matters worse, those who do use the guidelines often fail to include an important directive in the guidelines regarding their usage. The directive warns that to be accurate, plans should begin with the overall blended return expectation and then lower those expectations by all advisory costs and product charges incurred along the way.

Those charges typically range from 1.25 per cent to 2.25 per cent annually. The 75/25 growth-oriented portfolio used in the example above should only be projected to return 4.5 per cent with the lower costs, and that drops all the way down to 3.5 per cent with the higher costs.

You will probably be able to deduce why things are being done improperly. Motivated reasoning, self-serving bias and wishful thinking all come into play when examining the recommendations being made.

Simply put, many people would forego the services of a planner and/or those of an adviser or portfolio manager if they realized the net benefit would be so modest.

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Specifically, imagine if you could get 3.5 per cent in a guaranteed investment certificate (GIC) while taking no market risk whatsoever, while your adviser was recommending a 75/25 portfolio constructed using mutual funds with an average management expense ratio (MER) of 2.25 per cent. You would be taking a significant risk while earning no more (net of costs and fees) than you would if you simply parked your money in a risk-free vehicle.

The combination of low expected returns with still-too-high product and advisory costs represents a monumental challenge for the financial services industry, yet no one seems willing to talk about it.

The definition of cognitive dissonance involves the mental discomfort that results from holding two conflicting beliefs, values or attitudes. Like any professional, financial planners want to add value for their clients, but they also want to do so in a way that allows them to maintain their professional integrity and justify their fees.

As people seek consistency and alignment, this conflict causes unpleasant feelings. Something has to give. Either planners have to change their modus operandi or they have to soldier on as they always have while harbouring the dark secret that the services they offer may well be doing considerable damage to the valued clients they serve.

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The irony of this is that good planners are supposed to help their clients make rational financial decisions. As you might imagine, even the most virtuous planner will have a hard time going to clients with the recommendation that he or she be fired.

As a result of this conundrum, it seems that virtually all financial planners have chosen to sweep the problem under the rug to avoid the discomfort that would otherwise ensue.

In the famous words of writer Upton Sinclair, “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

To hear planners tell it, they don’t recognize the problem. Instead, it seems all financial planners are suffering from one of two afflictions. Either they’re oblivious to their own obligations regarding professional guidelines or they are aware of those obligations and are deliberately ignoring them.

I don’t know which is worse, but I genuinely believe the problem is existential. It is high time this problem was brought into the open.

John De Goey is a portfolio manager at Designed Securities Ltd. (DSL). The views expressed are not necessarily shared by DSL.

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