You might have expected that the headline of the Weekend Australian Financial Review's lead article would have put a shiver down the spines of financial advisors like ourselves - "Spotlight on Financial Planners - High Price for Advice". To be frank, I was a touch hesitant at first in reading the article but on reflection found that there were a range of comments made in the article that highlighted in a positive light the services of some financial advisors. I wanted to address a few of these points.
1) The key problem is that financial planners have been paid in trail commissions from fund managers and not their clients.
Trailing commissions are payments by fund managers to financial planners for directing the planner's clients to invest in the fund - basically a reward to financial planners for using their product. The article quotes a study from the Industry Superannuation Network (ISN) that suggests four fifths of people believed commissions compromised independent financial advice. (Of course the ISN have their own bias in that their super funds do not pay commissions to advisors)
There is some truth to this argument. We are clear in acknowledging on our website and when communicating to current and prospective clients that we do not accept commissions from fund managers. There is actually a cash fund in our recommended portfolio for non super and pension clients that requires us to receive a commission. Every three months we return this commission to client accounts in full.
The reason for taking this stance is that we do not want to even be accused of providing clients with advice that is biased in any way.
That being said, we actually believe there are some grounds where financial planners using a trailing commission fee model can provide a really great service for clients, particularly those with smaller funds to invest, as long as they are not encouraged to recommend particular investment because of the commission. Commissions can make financial advice affordable.
The key point, as mentioned in the article, is that the investments / products that are recommended are done so with the client's best interests in mind.
2) There is a confusion amongst investors about payments that are received by financial advisors.
This is for us the key issue. A financial advisor must be providing clients with all of the information about payments they are making, or the product that they are using is making to advisors. Clearly showing the dollar value of these fees along with the percentage fee is really crucial.
A fee that is very rarely mentioned is what are called volume rebates.
Volume rebates are where a financial product provider "rewards" a financial advisor for directing their clients to a particular product or service by providing them a volume rebate. The level of the rebate increases as the amount of funds directed to the product provider increases.
We utilise an administration service for clients. Our group of financial advisory firms receives a significant rebate from the service because of the large amount of assets which are invested with the service. A financial advisor has three basic choices here, keep the rebate for themselves or pass it back to clients, or a combination of the two. We choose to pass the rebate back in full to our clients and in doing so significantly reduce the administration service fee by almost half.
3) Are asset based fee models the same as trail commissions?
There is a clear distinction between the two. A financial advisor using a trailing commission fee model is being paid for recommending particular investments whereas an assets under management fee model advisor is being paid based on the total amount of assets the client wants managed by them. The second are free to recommend investments they prefer for clients without being biased by commissions from a particular product.
The article suggests that another problem with trailing commissions or asset based fees is that investors do not understand how the payments grow over the years. This is a fair point. The usual reason for seeking advice in the first place is to grow your level of investments. Under a trailing commission or asset based fee arrangement, the dollar amount of fees grows as the value of the investment grows.
The asset based fee model is sound as long as fees are capped, i.e, they do not grow without limit. We place a $4,400 cap (GST inclusive) on our client portfolios. This means that no client will ever pay us more than $4,400 (less GST) per annum. Thereby clients can be absolutely sure of the outer limits of the fees that are payable to the advisor.
4) Getting out of a relationship with a financial advisor is difficult
The article also implies that under the commission fee structure, clients can stop having an ongoing relationship with an advisor but continue to pay the trailing commission fees. This is a problem with trailing commissions. Advisors set clients up into particular investments and can do nothing ever again while still receive ongoing payments into their accounts.
We are open with our clients that they can choose to cease ongoing advice whenever they want to. From that point onwards no more advisor fees will be paid into our account.
We also do not charge upfront fees for this very reason. We do not want to place barriers in the way of clients to get in or get out of our advisory services. Payment of an upfront or annual fee paid once per year can make clients feel like they have to keep using the service to get their money's worth. We feel it is much healthier for clients to know that they can move to another financial advisor should they feel the need.
The article particularly targets financial planners that use trailing commissions on the basis that this type of fee structure causes planners to be biased in their choice of investments and thereby not working in their client's best interests.
There is some validity in this argument - take the Westpoint disaster as an example. However, investors should not be put off looking for good quality, unbiased advice because of this. Look for a financial advisor who can clearly identify the costs involved with their advice and who are not biased because of their fee structure or because of who "owns" them.