5 Common Misconceptions About Financial Planning

1.  You Don’t Need A Financial Advisor

What this really translates into is ‘help and advice are not worth paying for’. However, the vast majority of us rely on the skills of specialists to give us guidance and provide their services. Ask yourself this, would you perform your own appendectomy? Draft your own legal documents? How about re-wire the electrical panel in your home?  Maybe change the brakes on your car? Assuming you choose to attempt any of these tasks yourself, do you think you will do the job as well or better than a professional? More importantly, do you have the time and the expertise to get the job done right? Without proper education and training, attempting any of the above is either incredibly risky or reckless, possibly both. Strangely, for some people the thought of paying a professional to help them make sound financial decisions and develop healthy financial habits seems unreasonable. Independent research, as well as academic studies have proven that those who seek out professional financial advice are not only wealthier, they also have better saving habits and are more confident in their ability to meet their long-term financial goals. Isn’t that valuable?

2.  Financial Advisors Aren’t Trustworthy

It’s hard to say where this notion came from. Certainly the media plays a part and undeniably there have been cases of unscrupulous financial advisors. But individuals with a lack of ethics are not unique to the financial industry. There’s an abundance of vocations that have seen their fair share of misconduct; doctors, lawyers, police officers, teachers, mechanics, politicians - just to name a few. Nevertheless, in the eyes of some, the behaviour of a handful of financial advisors seems to have reduced the entire profession to be viewed as dishonest. Determining the trustworthiness of a financial advisor isn’t as hard as one might think. There are a few simple things you can do to help weed out the bad ones. First, perform a background check on the advisor's registration with the Canada Security Administrators, this will confirm who they work for and that they are who they say they are. Next, find out if there are any previous or outstanding disciplinary actions against them through the Ontario Security Commission. If the advisor has any credentials, like a Certified Financial Planner designation, you can contact the organization they are held with to confirm that the advisor is in good standing. Finally, and most importantly, talk to people. Request references and be sure to ask a lot of questions. If you still aren’t satisfied, don’t be afraid to ask for a few more – if the advisor is trustworthy they should be able to give you as many as you need.  Finally, use your judgement. If something doesn’t feel right then move on and find someone else.  Your financial advisor should be someone you implicitly trust; there is no room for doubt.

3.  Big Banks Are Best

Banks play an important role in our economy. They are the backbone of our financial system and it couldn’t function without them. Nevertheless, just because a bank handles your chequing account or holds your mortgage doesn’t mean that they need to be the ones to provide you with financial planning and advice. It’s conceivable that the investment recommendations that you receive from the bank may be biased. How so? Sales quotas and proprietary investment products aren’t necessarily designed for the benefit of the client, and in some cases they can potentially be a conflict of interest. If you are working with someone at a branch level, many times investment recommendations are made before there is a sound understanding of the client’s financial situation and their goals. With big marketing budgets and a significant presence in our communities, it’s understandable that many people find the big banks to be safe and familiar. However, like most public companies, banks tend to be accountable to one key group – their shareholders. You may be a ‘valued customer’, but your banks biggest focus is its bottom line. Shareholder happiness is a result of big profits. So from an investor’s perspective, is it better to be benefitting from that profit as a shareholder or adding to it as a customer?

4.  RRSPs Are A Type of Investment

“I don’t invest in RRSPs because they don’t earn enough”. Surprisingly, there are a number of educated people with a serious misunderstanding of what a Registered Retirement Savings Plan, or RRSP, actually is.  A RRSP is not an investment and it doesn’t have a rate of return. Think of a RRSP as a box that you are using to put your investments in. What you earn in your RRSP is based on what investments you put in that box. What is permitted as an investment in an RRSP varies, it could be a GIC, bond, stock, mutual fund, ETF or even certain mortgages (for a detailed list of what Canada Revenue permits click here). When your investments are in the ‘RRSP box’ any resulting investment income is not taxable. In addition, you are able to deduct the amount you put in the box from your taxable income in the year it was contributed. Depending on your income this can amount to some serious tax savings. When you eventually take the money out, which you will have to do at some point as there is a minimum withdrawal amount that starts at age 72, the entire amount withdrawn will be considered taxable income for the year in which you receive it. So, it is not so much a tax shelter, as many may believe, but really a tax deferral. The key principle is that you make contributions in your higher earning years and then withdraw your money in years when you have a much lower taxable income. As such, the RRSP can be incredibly valuable financial planning tool.

5.  Real Estate Is The Ultimate Investment

This is not a disagreement about whether or not to invest in real estate; it’s about investing EVERYTHING in real estate. If someone were to invest all their savings in one company it would likely be considered foolish. The pitfalls of this approach should be obvious - if your investment fails you put yourself at an incredible amount of risk to lose everything. Therefore one of the fundamentals of a sound investment strategy is to have proper diversification. In recent years we have seen the value of real estate skyrocket. This increase has led to many people putting most, if not all, of their savings in to the real estate market with the belief that it is risk-free and almost guaranteed to make them wealthy. The reality is that the real estate market is fraught with risk. First, consider the market risk – this is what the property is worth to a buyer. Much like the stock market the housing market fluctuates. What it is worth today is not necessarily what it’s going to be worth tomorrow. Next, there is the liquidity risk – which is the ability to find a buyer when you want to sell it. In some cases this can take years. Real estate is only worth what a buyer is willing to pay and only when they want to pay it. In addition, many don’t consider the ongoing costs associated with owning property – there is insurance, maintenance, and don’t forget the tax on any rental income and capital gains when the property is sold. When you do the math the rate of return on a real estate investment may not be as substantial as you had initially thought. Remember, technically your home is not an investment as the definition of an ‘investment’ is an objective to generate a profit. Even though the value of your home could increase between when you buy it and the when you sell it, your primary objective is to live in it. It’s also important to keep in mind that any profit from the sale of a principal residence is not taxable. Some real estate isn’t a bad thing; just make sure you’re not putting all your eggs in one basket.