Developing a financial plan to build and improve your future can be a rewarding activity. Many people are willing, able and even welcome the opportunity to undertake this task themselves.
Others prefer to engage with a licensed financial adviser to offer guidance through the decision making process. If you’re inclined to seek the services of an adviser, here are some tips so you don’t end up spending your hard earned money on unnecessary or poor advice.
The key point is to understand how financial advisers earn a living.
Many advisers earn product sales incentives, especially in the form of commissions, bonuses and profit shares (sometimes called ‘conflicted remuneration’).
These incentives cause so-called ‘conflicts of interest’ which may improperly influence advisers to promote and sell financial products whether or not you need them. This has been shown to be a long-standing and widespread problem, not just the behaviour of a few ‘bad apples’.
Many unsuccessful attempts have been made by governments to reform the financial advice industry so as to remove these conflicts of interest. The latest attempt is a compulsory Code of Ethics. Time will tell whether the Code improves the industry’s behaviour. In the meantime, you should be aware that when you consult a financial adviser, incentives and ‘conflicts of interest’ are likely to influence the adviser’s advice.
The main form of so-called commission used in the industry is often called an ‘asset fee’. This is a percentage paid by clients on their investments. Some advisers misleadingly call this form of commission a ‘fee for service’. This causes many people to believe that it’s not a commission at all.
6 Real Life Examples
Here are some common examples, sourced from ‘real life’ in consumer financial education, demonstrating how asset fees can lead to poor outcomes for consumers due to the impact of conflicts of interest:
1. The Inheritance
A client inherits $100,000 and consults a financial adviser who charges asset fees. The client seeks advice on whether to pay off a mortgage or invest in an investment product recommended by the adviser. The adviser is inclined to recommend investment of the inheritance in a product from which an asset fee can be earned, rather than reducing debt on which nothing can be earned;
2. Industry Superannuation Funds
A client is thinking of using an industry superannuation fund and asks a financial adviser for a recommendation. The adviser who uses asset fees cannot easily charge them on an industry superannuation fund, but can readily do so if the client uses a superannuation fund promoted by the adviser;
3. Government Superannuation Funds
A client is a military retiree thinking about how much of a government-guaranteed defined benefit pension entitlement should be taken as a lump sum. The client seeks advice from a financial adviser who uses asset fees. The adviser cannot charge asset fees on a government-guaranteed defined benefit pension, but can charge them on certain private sector products. As a result, the adviser recommends that the client should take the maximum lump sum and invest in those products;
4. Term Deposits
A client has $250,000 in term deposits with a bank, maturing next month. The client asks the adviser for a recommendation about where to invest. The adviser can’t charge asset fees on the rollover of term deposits, so recommends the use of an investment product on which an asset fee can be charged;
5. Cash at Bank
A client has $250,000 in a retail share fund through a financial adviser who uses asset fees. The adviser believes it would be in the client’s best interests to move some of the money into cash at a bank (noting the $250,000 government guarantee), but is not inclined to offer that advice because the asset fee cannot be continued if the money were to be moved into cash; and
6. Investment Property
A client has $500,000 in savings and seeks advice about investing it in direct real estate. The financial adviser is inclined to persuade the client to move the money into a range of investment products on which an asset fee can be charged because moving it into direct real estate will not allow that fee to be charged.
The list goes on. On each occasion, the financial adviser who uses asset fees has a conflict of interest because unless an asset fee is charged the adviser earns nothing. Other types of incentives that may lead to poor outcomes for clients include bonuses, profit shares and commissions on life insurance, mortgage broking and direct property sales.
The key point to understand here is how incentives are designed. If they are designed to encourage product sales, this should cause a client to ask:
In whose interests is the advice being offered?
There is a growing number of financial advisers who have no remuneration-based conflict of interest. They only charge genuine ‘fees for service’ calculated on an hourly rate or a flat fee. There are no percentages or product incentives, ever. By appointing such an adviser, clients have the best chance of receiving advice that provides value for money, can be trusted to be free of conflicts and is in their best interests.
Unfortunately, the bulk of the financial advice industry is not structured in such a way that the average Australian can obtain reasonably priced advice that suits their relatively simple needs and limited means. Therefore, it’s important to be realistic, sceptical and to take your time. Make a point of understanding the costs and conflicts involved in the services that are being offered. And understand the costs in dollars, not just in percentages which can sound misleadingly low.
Finally, you should remember that just because an adviser has no remuneration conflicts of interest doesn’t necessarily mean the adviser will be comprehensively knowledgeable about military employment conditions and entitlements. These are things the adviser can readily research, sometimes with your assistance.
However, freedom from remuneration-based conflicts does mean that the financial advice is much more likely to be given in your best interests which must surely be the most important feature of any trusted professional relationship.
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