Experience with a financial advisor?

[morechitlins]

First post and its a long one so please bear with me! OK, so my friend set me up with a meeting with a "financial advisor". This is what he outlined for me:

$100,000 B2I investment loan @ Prime + 1 or 3.5% annually:
Payment would be 3500$ a year or about 291$ a month.

This B2I is expected to grow at 10% per year (as history shows).

I have also included an illustration on how IRP would work if we
follow the strategy I outlined last night.
I fast forwarded your age to 7 years later and then applied the
illustration, you will see that we take about 16,000$ a year from your
B2I policy to fund your IRP for 20 years. After that it will grow tax
free, and at age 65 you can either take out close to 100,000$ a year
as income, or you can borrow against it tax free for the remainder of
your life, guaranteeing you retirement income.

B2I = borrow to invest in a non-registered account
IRP = insured retirement plan, another name for universal life i guess.

I believe this package is in partnership with Canada Life who I guess is the one issuing the loan at such a low rate.

I already don't like the fact that he's trying to sell me a Universal life plan so lets leave that out. I outlined the following concerns/reasons I have:
a) I am not comfortable with the idea of taking on 100k worth of debt as it would impact me in the future say when I need a mortgage for a house ( I am in my mid twenties )
b) In my opinion, 10% ROR is unrealistic, anything lower will cause the B2I -> IRP plan to fail. "Canada Life Harbour growth and income" is the fund he used as an example to show the superior performance it has over its index with mid teen ROR each year, but it has a MER of 3% and has only been around for 10 years.

His reponse is:

a) When it comes to debt, there is good debt and bad debt. Bad debt
is simply any loan you may take out to buy something that may go down
in value, e.g. Electronic items or a Car Loan.
Good debt is simply any debt taken out in order to buy something that
will increase in value, e.g. an investment or a property. This
concept is very basic in the financial industry and I believe you have
probably heard it many times before elsewhere.

The B2I loan is unique in that it is secured and backed by the
Principle Guarantee that is a feature of Segregated Funds. This
feature is required by law of any Seg Fund, thus it will protect your
borrowed principle up to 100%, insuring you that you will never have
to pay back the principle even in the worst case scenario that your
investment drops to 0.

That being said, the B2I loan is one of the most secure loans you can
get because of the Principle Guarantee (which by the way is guaranteed
on contract by the insurance company itself, e.g. Canada Life or
Manulife.) No other borrowing to invest strategy will guarantee your
principle, not even a mortgage, and certainly not mutual funds or
stocks.

b)I am curious to understand why you do not think that 10% rate of
return is not realistic. I showed you that for the past 58 years,
despite some of the worst financial situations in history (including
the huge market drop in 2008), the TSX, S&P, and world stock markets
still made 10-12% ROR average. I also showed you that if you left
your investment in for minimal 15 years, there has been no case in
history where you would've lost money. We are also picking funds that
out-perform the index, however I understand that you may not trust our
judgement in that matter. If that is the case, you always have the
option to pick index funds which at the least, should make the 10-12%
stated before.

Lastly, please be aware that any fund performance I show you is
recorded after MER has already been deducted. This is standard
practice in our industry, and there are multiple performance charts
that outline the different performance values based on the MER package
you have chosen.

Principle Guarantee? never have to pay it back even if my portfolio loses its value? Sounds incredible, but I am not familiar with these investment options insurance companies offer, so maybe someone with knowledge and experience can explain this to me.

And the rate of return debate, I believe this goes back to the active managed vs index argument. If the index is getting 10% on average, is it unrealistic to expect a actively managed fund with a high MER to outperform it for the same duration?

Basically, I am trying to get some opinions and arguments on if I should believe his points or not and if this actually a good strategy. Also, the commission is 5% on all deposits, so that $100,000 initial loan/investment is actually $95,000.

[CanadianCapitalist]

I don't think this is a good strategy at all. Here's why: assume that the premium you get for bearing the risk of investing in stocks compared to cash is between 4% to 6%. Because the loan is Prime + 1% and the MER is 3% and Prime itself has a 2% premium over the risk-free T-bill rate, the extra return expected from stocks is now reduced to -2% to 0%. Do you really want to take the risk of stocks plus that of a loan when you expect to not even make a profit?

Now look at the motivation of the advisor. He probably collects a 5% commission on the initial $100,000 invested plus about $500 to $750 in trailer fees.

[morechitlins]

assume that the premium you get for bearing the risk of investing in stocks compared to cash is between 4% to 6%.

Are you saying investing in stocks will have a 4-6% rate of return advantage over cash? by cash do you mean bonds and stuff like that? i don't really get this assumption. sorry im really a noob.

[CanadianCapitalist]

Originally Posted by morechitlins

Are you saying investing in stocks will have a 4-6% rate of return advantage over cash? by cash do you mean bonds and stuff like that? i don't really get this assumption. sorry im really a noob.

Yes. By cash, I mean Government of Canada issued T-bills maturing in 90 days. The past record for excess returns provided by stocks over bills/cash for the 1900-2000 period has been 4.7% for Canada and 5.8% for the United States [Source: Triumph of the Optimists]. I really don't know where these financial advisors get their data. Also here is the 10-year equity premium versus bills for 1900-2000:

3.5%
2.4%
8.8%
-0.5%
8.4%
12.9%
5.2%
2.5%
0.0%
3.5%

Only 3 10-year periods have stock returns that are 6% or more than bills. 6 10-year periods have stock returns that are 4% or less than bills. That is you have a 60% chance of losing money with leveraged investing of the type described in your post.

[morechitlins]

Ah i get it.

It seems his logic hinges on the fact that he will be investing my money into these hot seg funds with their 15-18% returns which are brought back to earth with their big MERs. And given the fact that less than 10% of all funds out there perfrom better than the index in a 10-year period, it sounds like gambling to me.

Im pretty much convinced. Thanks!

[Financial Highway]

I agree with CC on this one. However I dont think the advisor is selling you a UL product, he is talking about seg. funds and yes they do provide a minimum of 75% with an optional 100% guarantee at maturity or death. So in 10 years you are guaranteed to have at least your principle. This is something only life insurance companies provide (also a big reason for Manulife's stock drop).

Second his 10% ROR is just way too optimistic.

This is a strategy many "advisors" encourage who are mainly insurance agents. I remember when I was working for a firm this strategy was promoted heavily, one of the reasons I left.

Also interest rates will start going up your rate will not be 3.5%.

Just out of curiosity, has this advisor met with you? or anything like that?

[morechitlins]

yes he has met with me. He did try to sell my a UL policy as well. Basically his whole idea was to start taking funds from my non-reg account where the 100k was invested to start buying into the UL (16k/year) starting at the 7th year of this plan. A quick calculation shows that anything less than 10% ROR will cause this strategy to fail since eventually my non-reg account will have zero money left and I will still need to pay for the UL. Clearly a bad idea, thats why I didn't make this the point of my questions

The main reason I met with him was my other friend has recently joined the this industry and he gets $$ for referring potential clients, so I was really just doing this as a favor. But after seeing what their pitch is and what they trying to sell, I might tell him to get out haha but he seems pretty excited about all this stuff.

[canehdianman]

This is a GREAT strategy!!!!!!!

.............. for the financial advisor.

[DrStan]

Run as fast as you can. Just perusing the arguments put forth by your “advisor” makes for a good laugh. I would call him out on the following:

1) No one in their mid-twenties should buy segregated funds. Your capital is guaranteed years down the road. Well sorry, but getting your capital back won’t cut it, since the value will have been severely eroded by inflation. Anyways, the “advisor” is convinced that you’ll easily make 10-12 percent a year. So you don’t need a guarantee, right? Duh. This guy probably doesn’t have his “real” mutual fund licence so he’s trying to sell you seg funds which are a form of insurance.
2) The MER is gross, bordering on theft. At your age, please do yourself a favor. Buy low-cost index funds gradually over the years and you will do great. You can put together a nice basket of ETFs or index funds for about 0.5% fees per year.
3) The projected returns are highly optimistic. I would count on much less, 6-7% a year. Better be conservative in your calculations.
4) Interest rates are at an all-time low. They will eventually rise. A couple of points could ruin you.
5) This “investment” takes away a lot of your financial flexibility by committing you to one (poor) strategy. Build up your RRSP, your TFSA and your non-registered savings. If and when you buy a house, you can take money from these sources as a down payment.
6) This guy is just looking for a nice commission. Ask him how much he stands to make, and to lay out the numbers for you. Initial commission and annual trailer fees. He’ll squirm in his grey suit.

Cheers!

[venter]

As a Financial Planner (CFP), I am appalled by this guy. Putting the dubious nature of his claims aside for the time-being, has he even bothered to identify your investing goals and risk tolerance? On what basis did he decide this was an appropriate investment for you? As far as his fees, as a CFP I am obliged to disclose up front how I am compensated, I have found talking to prospective clients that this is apparently not common practice.