SUPERANNUATION

Developing a plan to build and improve your financial future can be a rewarding activity. Many people are willing and able 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, this video offers some tips so you don’t end up spending your hard earned money on unnecessary or poor advice. 

The main point here is to understand how financial advisers earn a living and how that might impact on the advice they offer.

The reality is that many advisers earn product sales incentives. These incentives cause so-called ‘conflicts of interest’ which are likely to influence advisers to promote and sell financial products to you, whether or not you need them.

This has been shown to be a long-standing and widespread problem in the financial services industry. It’s not just the behaviour of a few ‘bad apples’. Of course, we’re not suggesting that all financial advisers are dishonest, but we are saying that many advisers are conflicted, which may affect the advice they offer. 

Several attempts have been made by governments to reform the financial advice industry so as to manage or remove these conflicts of interest. These include a compulsory Code of Ethics which is regulated by the Australian Securities and Investments Commission.

Nevertheless, you should be mindful when you consult a financial adviser that incentives and conflicts of interest may influence the advice you receive.

The principal form of commission used by the industry on investments is called an asset fee. This is a percentage paid by clients on their invested funds. Sometimes, asset fees are misleadingly called “fees for service”.

Here are two examples of how asset fees are inherently conflicted and may lead to poor outcomes:

A client inherits $100,000 and consults a financial adviser who charges asset fees at the rate of 1.5%. The client seeks advice on whether to pay off a mortgage or invest in a financial product recommended by the adviser. The adviser recommends investment of the inheritance in a product from which an asset fee of $1,500 can be deducted, rather than reducing debt on which nothing can be earned.

A military member who is thinking about taking some of her government guaranteed indexed retirement pension as a lump sum consults an adviser who charges asset fees. The member is advised to take the largest possible lump sum, enabling the adviser to earn a substantial asset fee.

Clearly, in both of these examples, the financial adviser 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 commissions on life insurance, commissions on mortgage broking and direct property, sales bonuses and profit shares.

Here are four examples that demonstrate the point:

A client who has a large amount of life insurance through membership of a superannuation fund is thinking about whether or not to buy additional life insurance. He consults an adviser who recommends a new life insurance policy on which the adviser will earn commission paid by a life insurance company. While the client may need the insurance, the adviser is conflicted because he can only be paid for the advice if the client buys the product.

A client is thinking about establishing a property portfolio. She consults an adviser who recommends the purchase of a property from a developer with whom he does business. The adviser also recommends that the client should borrow the money to make the purchase through a company related to the adviser. A conflict of interest exists because the adviser will earn a commission on the real estate sale and on the establishment of the mortgage; whereas if the client doesn’t proceed, the adviser will earn nothing.

A client is considering the idea of setting up a self-managed superannuation fund. He consults an accountant who is also a financial adviser. The accountant says he is a superannuation expert and that he administers a large portfolio of self-managed superannuation funds. He recommends that such a fund be set up for the client and offers to advise on the investments in it. In this situation, the client should consider the accountant’s financial incentives. For example, does the accountant have an incentive to establish a new self-managed superannuation fund to add to his existing client base? Has the accountant properly considered other simpler options? Also does the accountant get paid for arranging the investments of the fund, and if so, how?

A client consults an adviser about how to invest the family’s savings. The adviser reassures the client that because he works on a salary only, receiving no commissions, asset fees, profit shares or product sales bonuses, that there is no conflict of interest which may impact on the advice. On making further enquiries, the client discovers that the adviser is required to meet certain product sales targets, including on his employer’s “in house” products. Clearly, the adviser is conflicted because if the targets are not met, his career prospects and ongoing employment may be in jeopardy.

The key point here is to understand the behavioural impact of incentives. Not all incentives are bad. However, If they are designed to encourage product sales, this should cause you to ask yourself: In whose interests is the advice being offered?

There is a growing number of financial advisers in Australia who have no ownership, licensing or remuneration-based conflict of interest.

These advisers are truly independent. It’s worth noting here, that in the financial services industry, the word independent has a specific legal definition that doesn’t always mean an adviser will be free from remuneration-based conflicts of interest. For example, advisers may claim to be independent while charging asset fees or they may take commissions on mortgage broking or direct property sales. However, truly independent advisers will only charge you genuine professional fees for service calculated on an hourly rate or a flat or fixed fee. There are no percentages, ever.

This doesn’t mean that they are technically brilliant and will always give you the best advice at a price you can afford. However, it does mean that due to the absence of conflicts of interest described in this video, that the financial advice offered by these advisers is much more likely to be given in your best interests.

Unfortunately, the financial advice industry is not structured in such

a way that the average Australian can always obtain reasonably priced advice that suits their relatively simple needs and limited means. For example, some advisers are willing to undertake limited advice on specific issues such as superannuation or saving for a home. Whereas, others prefer to offer comprehensive and more expensive advice on the whole of a clients financial circumstances.

Therefore, it’s important to be realistic and sceptical, and to satisfy yourself that the adviser is suitable to your requirements. Ask questions and to take your time. If you feel you’re being pressured to make a decision or your concerned the adviser won’t meet your needs, walk away.

Here are some key points for you to consider when deciding who to appoint as your financial adviser:

1) Make sure the adviser is properly licensed by the Australian Securities and Investments Commission. You can check this on the Financial Advisers Register at moneysmart.gov.au; being licensed doesn’t necessarily guarantee that the adviser will always give you advice in your best interests but atleast you can feel reassured that a licensed financial adviser has satisfied the minimum legal requirements to qualify for a license. Whereas, a person who offers financial advice without a licence is breaking the law and may be seeking to defraud you.

2) Understand who owns the adviser’s business and the adviser’s Australian Financial Services Licence. This would be important if for example the advisers employer has their own in house or preferred financial products which the adviser is expected to support.

3) Understand how the adviser get paid and how that might impact on the advice you receive;

4) Ask about the adviser’s educational qualifications and how much experience the adviser has in advising someone like you. Tertiary qualifications and experience don’t guarantee a good outcome, but they might give you some comfort;

5) Make sure any advice that is offered by the adviser is in writing, that you understand the advice, its scope, it’s conflicts and the costs of it in dollars (not percentages), both up-front and on-going.

Having satisfied yourself about all of these points, you’ll be in a much better position to make a well-informed and carefully informed decision about who to trust to advise you in your best interests about your personal financial affairs.