One of your biggest investing decisions

Two distinct approaches

To start with, it's important to understand that there are lots of different types of advisors, and the distinctions are not generally well known by the investing public. There are two distinct approaches to managing investments, known as discretionary (which means the advisor makes the day-to-day decisions of what to buy and sell, subject to your overall direction) and non-discretionary (which means the advisor provides advice only and you must approve every investment transaction). The minimum requirements to be a non-discretionary advisor ensure only basic investment knowledge and obligates them to only sell suitable products, although of course many of them far exceed the minimum standards with high levels of expertise and professional dedication to their clients.

In contrast, the minimum standards for discretionary advisors are significantly higher. They have to live up to a fiduciary standard which obliges them to work in the client's best interest. They also need to attain a higher level of knowledge, since to be a full discretionary advisor requires them to achieve either the highly regarded Chartered Financial Analyst (CFA) designation, or the less rigorous but still well respected Chartered Investment Manager (CIM) designation.

Advisors selling investments fall into three main licensing silos. The largest group are mutual-fund advisors (82,900 registered representatives, who go by many different titles). They sell mutual funds on a non-discretionary basis, but can't sell individual stocks and bonds. With rare exceptions, they can't sell exchange-traded funds either. They generally serve small- and medium-sized accounts in bank branches and elsewhere.

The next largest group are brokers (27,500 registered representatives, with different titles but often called investment advisors). They can sell mutual funds, ETFs or individual stocks and bonds, traditionally on a non-discretionary basis, but a growing number are discretionary. They serve medium and large accounts through bank-owned or independent brokerage firms.

The third group are investment counsellors (4,800 registered representatives, also known as portfolio managers). They manage money on a discretionary basis for large accounts through bank-owned or independent firms. It is important to note that while the banks are fairly dominant in each channel, the three types of bank advisors are located in three distinctly different divisions of the banks. In addition, a separate insurance licence (another silo) is required to sell insured products like annuities and segregated funds.

In order to find the right advice, it's important to know what to look for. A lot of people think that an advisor's job is mainly to select individual investments that try to beat the market (if you're an active investor), or match the market with very low fees (if you're a passive investor). But that is only part of the story. It is perhaps more critical to ensure that these building blocks are selected so that they fit together nicely in a well diversified portfolio with the appropriate asset allocation that matches the financial objectives, risk tolerance and other financial circumstances of the individual. Then, once you have the right portfolio, your advisor should help you maintain it by rebalancing when different asset categories diverge from their target. In general you need to focus on the forest, not just the trees. "A suitable portfolio is the most important thing for the investor," says Eric Kirzner, professor of finance at the University of Toronto's Rotman School of Management.

A good advisor should help you make effective use of RRSPs, TFSAs, RESPs and non-registered accounts, helping you to understand how best to tax-effectively put money into them and later take money out. Your advisor should provide clear information on how your overall portfolio has performed, compare the performance of each major investment category to a benchmark and forthrightly disclose all investment fees.

You need to be able to trust that your advisor is looking out for your best interests, whether they are legally a "fiduciary" or not. Of particular importance, they should be someone who you can count on to give you good emotion-calming advice in stressful circumstances, such as when markets decline. It helps if your advisor or someone else at the advisor's firm can prepare a full financial plan if needed, although some investors prefer to use a separate planner. While credentials aren't everything and savvy experience counts for a lot, look for indicators of higher-level skills such as the CFA and CIM designations, as well as financial planning designations like Certified Financial Planner (CFP) and Personal Financial Planner (PFP).

The advice gap

There has long been an "advice gap" in the industry, where full-service advice is much more likely to be available for large accounts and not small accounts. That reflects the economic reality that getting lots of good quality advice is expensive and not everyone can afford to pay for much of it. Fortunately, robo-advisors and other new business models are starting to narrow the gap.

ETFs are increasingly used as low-cost building blocks for constructing portfolios, which can help reduce overall fees. ETFs are the building blocks of choice for robo-advisors, and are increasingly being used alongside other investment products by brokers.

Some industry trends have indirect benefits. In particular, the growing trend toward more discretionary advice in the broker and robo-advisor channels is providing an indirect boost in advice standards because discretionary management entails a fiduciary standard and also requires higher-level advisor credentials.

Certainly the industry is heavily criticized for its fees, especially those for mutual funds. While much of that criticism is well founded, it's easy to take the wrong message from it. Some people think it means they should always try to cut investment fees to the lowest possible level, but that's often a mistake if you lose access to good advice when you can benefit by it. Thoughtful proponents of both active and passive investing are usually firm believers in advice being worthwhile, when it is well done, reasonably priced and needed. "It comes down to value for advice," says Kirzner.