Personal Finance is receiving an increasing number of letters from readers complaining about financial services companies that force you to invest through a financial adviser. And, if the companies do let you "go direct", they charge you a "marketing" fee, which is equivalent to the commission or fee you would have paid the financial adviser.
I sympathise with the reader who said this practice amounts to nothing less than a "protection racket".
I also sympathise with the reader who discovered that, although his financial adviser had emigrated and was not providing him with any advice, the adviser was nevertheless receiving an annual fee/commission.
Another reader found that his adviser had sold his business to another company. The company was receiving the fee/commission that previously went to the adviser, even though it was not providing the client with any advice.
The issue becomes more interesting when an independent financial adviser is involved, because financial services companies refuse to take responsibility for the consequences of the advice they provide, even though the companies enter into contracts with independent advisers to sell their products.
In other words, they may be insisting that you are advised by an idiot - and there is ample evidence to show this has, in fact, occurred.
Do you need an adviser?
Tthe issue of whether or not you should invest through a financial adviser is not a simple one. It should be approached with a great deal more care than many financial services companies are taking.
The factors you need to take into account include the following:
- Advice.
Most people need financial advice, because financial products are complex, and the average person does not have the knowledge or the time to assess the array of products on the market. You also need holistic advice that takes account of your financial needs and goals.
The problem is that even after the Financial Advisory and Intermediary Services Act is fully implemented next month, you cannot be completely sure that you will receive sound advice from a financial adviser.
The only people really qualified to give investment advice are Certified Financial Planners (CFPs) accredited by the Financial Planning Institute (FPI). (I specifically mean CFPs, and not associate members of the FPI.)
On the other hand, there are ordinary investors who do have the time and the expertise to make sound investment decisions, without paying often high costs to receive - in some cases - inappropriate advice.
A case in point is the very sorry history of living annuities, where advice that was often appalling resulted in thousands of pensioners facing destitution. The main reason for this was that financial services companies allowed unqualified people to sell and give advice on complex products.
- Abusing advisers.
Some financial services companies claim that if they allow you to go direct and not pay a commission or an equivalent fee, you will go to a financial adviser, receive advice and then invest directly, leaving the adviser out-of-pocket.
This is a problem and is unacceptable. You should pay for any advice you receive. But there is a simple solution. If you seek advice from a financial adviser, the adviser should tell you upfront that he or she will charge an hourly fee for the advice.
The fee must be negotiated, and would depend on the extent of the advice and the adviser's level of expertise.
If you choose to purchase a financial product through the adviser, any commission or fee payable by the financial services company on the product should be deducted from the hourly fee you paid directly to the adviser.
Paying a hourly fee for advice is far better for all parties concerned. It removes the temptation for advisers to sell you a product simply to earn a commission, or to mis-sell you a product because it pays a higher commission than one that is more suited to your needs. The good news is that the better financial advisers are charging a fee for their advice.
I have never understood why the cost of advice or a sale should be based on a percentage of the value. This does not only apply to the financial services industry, but more particularly to estate agents. Some agencies try to insist on a commission of 7.5 percent of the sale price. This is ludicrous. Estate agents should be paid a fee based on costs plus a profit.
- Ongoing services.
Financial services companies say that financial advisers are taking over some of their administrative duties and payment for their services are included in the commissions or fees they receive.
This is not quite true, because, even if you invest through an adviser, the companies will, eventually, have to work on your case, for example, to issue documentation and to receive the correct documentation from you.
The key problem with investing through advisers is that the financial services companies treat the advisers as their clients and not you, whose money they receive.
What you should do
If you are certain that you do not need to approach a financial adviser, you should shop around and find out which product providers do not force you to use an adviser and do not deduct an equivalent fee from your investment. One such company is Allan Gray.
(If there are other companies that allow you to invest directly - without adding on replacement fees - let me know who they are. I will happily publish their names in Personal Finance.)
Some companies, although they profess not to accept direct business, will do so if the investment is a significant amount of money. So, do not simply take the initial "no" for an answer.
If you do require advice, you should insist on paying an hourly fee for it. Any commissions or fees payable on the products you purchase should be deducted from the fee you pay directly to the adviser for his or her advice.
You must also remember that with most financial products, there are both initial and annual commissions or fees payable to advisers. Both sets of commissions or fees are negotiable.
When you approach an adviser, you should insist that you are provided with details of all commissions and fees in three ways:
- As a percentage of your investment;
- As the rand amount you will pay over the entire investment period; and
- On a "reduced yield" basis. A reduced yield will show you how the costs will reduce the return you will finally receive. This should be calculated by taking all costs, assuming a rate of return and then comparing this figure with what your final total return would have been if no costs had been levied.
This three-way breakdown will enable you to clearly understand how the costs will affect your returns. An annual fee of, for example, 0.5 percent may seem very little, but it can have a significant impact on your returns over the long term.
Remember, it is your money and you are entitled to negotiate.