How to pay (and not to pay) for financial advice

For most of us who don’t work in the financial services industry, the thought of investing can seem quite daunting. The universe of investments is mind-boggling and there are literally tens of thousands of stocks to choose from, and equities is just one asset class – there is also private markets, real estate, fixed income securities and so on. It is evident why so many of us seek financial advice.

We devote our time towards working, in pursuit of affording a good standard of living, both now and in the future. Making sure that we achieve our goals in life, whether that be retiring early or buying our dream home, requires making good decisions with our finances and above all, being disciplined.

Just as you would employ a personal trainer to help you with your fitness goals, a qualified and well-trained financial planner can help you with your life goals (not just financial).

It’s very important to be able to distinguish between an ethical financial planner and a slippery financial salesperson. One is driven to deliver good outcomes for you, whilst the other is driven to deliver good outcomes for themselves.

What is key is the way in which the adviser charges for their advice, what types of products they recommend and how they are remunerated. Financial advisers either earn a commission from products they sell or they charge a fee for service. Fee-based advisers can also be divided into those who charge flat fees (like a lawyer or accountant) and those who charge a percentage of your investment.

So, which option is better for our investments? A fee-based adviser. Flat fees particularly if you have a large investment portfolio, as a percentage can equate to a large amount and the flat fee ensures that this is capped.

Below we will demonstrate the difference in fees and charges between a “bad” financial adviser and a “good” financial adviser, based on a single investment of $250,000.

The “bad” financial adviser

This adviser is bound to recommend you an insurance-wrapped investment platform, which is typically referred to as a ‘portfolio bond’ or ‘offshore bond’. Whilst some argue these products have tax advantages for British or Australian expats, the main reason they are offered is the 7% commission the adviser earns. So, on your $250,000 investment, your adviser has bagged a healthy $17,500 paycheck.

Now, this is only just the beginning! There is much more juice to be squeezed… 

Once you have transferred your cash to the portfolio bond, the funds then need to be invested. One benefit of a portfolio bond is that it is “open architecture” meaning that you can invest in almost anything ranging from single stocks, mutual funds, ETFs, bonds and so on – much like an investment brokerage platform. For a bad financial salesperson, this can be like visiting the ‘Pick n Mix’ at your local sweet shop. Instead of creating a well-diversified investment strategy based on your goals, risk parameters and ethical preferences, the bad adviser will most probably select heavily promoted funds that pay an entry commission of 5% and/or ‘trail’ commission, which is usually 0.5% recurring annually on the size of your investment. These aren’t necessarily bad funds because they incentivise advisers as part of their marketing strategy, and many are well-respected with good returns. Many of you will be familiar with names like Fundsmith, Guinness… The good performance of these funds is easy to sell to you and I but the reality is that every fund manager has been making money over the past 15 years as markets defied gravity. However, no matter how good the performance is, the real issue here is the additional layer of cost, which significantly reduces your net returns.

Now you have your ‘core’ fund selection, it’s time to add something a little bit spicy – ‘structured notes’. Even the name of this instrument emits an air of sophistication, and that’s because they are. Structured notes are derivative-based investments designed for sophisticated or professional investors only, due to their complexity and high level of risk. In essence, a structured note is just another way of packaging up an investment in order to generate more commissions for the salesperson. For this working example, we will say that the commission earned by this bad adviser is 5% although some structured products can be loaded with up to 15% commission. Ouch. 

So, assuming that you have a portfolio consisting of 80% commission-paying funds and 20% structured notes; that equates to $12,500 in additional upfront commission. This financial salesperson is now sitting at a sweet $30,000 in revenue from your $250,000 investment – that’s a whopping 12%. The icing on the cake is the ongoing “advice” fee for “monitoring” your portfolio, which most advisers charge 1% annually for; however, some will tier this based on the size of your investment. In some instances, very bad advisers will charge an ongoing advice fee in addition to receiving trail commission from funds, which means they could be skimming 1.5% off the top. Therefore, on an annually recurring basis, you could be paying anywhere between $2,500 - $3,750.

In summary, entrusting your investments to the wrong financial adviser can lead to extortionate and often hidden fees and charges. Products that pay high commissions to financial advisers tend to have much higher costs, as it is your investment that pays the commission.

Total first year earnings: $33,750

The “good” financial adviser

Now, let’s look at how a good financial adviser charges for their services.

First of all, this adviser discloses what services they provide and how much they charge. This will usually be a flat fee for a recommendation, which can vary depending on the complexity of work. Using the same example, advice for an investment could cost $3,000. For this fee, you would receive a full financial planning report, investment recommendation and cashflow forecast. After this, you can either implement the advice yourself or have the financial adviser implement it for a fee equating to 3% of your $250,000 investment ($7,500). Sometimes, you will have no choice but to implement via a financial adviser as many products are not directly available to investors. So far, you have spent $10,500 in explicit fees, so you know what you are paying for and exactly how much.

The ongoing advice fee is standard in this adviser’s charging structure and will generally be tiered. This adviser charges 1% on a $250,000 portfolio.

Total first year earnings: $12,750 

Difference in earnings/fees = $21,000

How to pay for financial advice

The bottom line is that good financial advice is worth paying for. Working with an experienced and qualified financial adviser can not only help you grow your wealth but also save you a ton of money in tax planning, handholding and generally avoiding common pitfalls.

Paying a fee for service, as you would a lawyer or accountant, removes any potential conflict of interest or bias to a particular product or investment. This means you will receive the best financial advice.

A financial adviser should always disclose how they are paid in the initial meeting with you. Be sure to ask them for a breakdown of their fees and charges and if they are ‘independent’ or ‘tied’ – tied means your options are more limited, as the adviser can only recommend their company’s products.

Read more on how to choose a financial adviser or visit Profezo to find a vetted professional.