A Planner Speaks Out

As a practising financial planner, I wish to join Eureka Report’s call on my industry to abolish commissions for advice.

From industry colleagues, I have heard every lame excuse for commissions:

• Small investors cannot access good advice without commissions.
• If it’s fully disclosed, it should make no difference.
• If it’s not coming off a client's investment, why should they care?
• Travel agents, car sales people and even doctors accept payments from products.
• If there are two equal products and one is prepared to pay me more commission than the other, I’d be a mug not to pick the biggest payer.
• It’s just a collection issue; if a product collects my fee from my client rather than me collect my fee from my client, why should my client care?

Commissions are rife in the financial planning industry, but the fact remains that all commissions are designed to encourage advisers to recommend one product over another. These are the main forms of commission:

Entry commissions are deducted from the investment, reducing how much you have invested on the first day. These must be disclosed.

Manager commissions are not deducted from your investment, but paid out of the fund managers’s pocket. They exist solely to encourage advisers to recommend a product. These must be disclosed.

Soft dollar commissions are non-cash incentives paid by the manager to advisers to encourage advisers. They include travel, toys, and entertainment. These must be disclosed.

Trailing commissions are paid monthly or quarterly to advisers based on client investments kept in a product. These must be disclosed.

Volume bonuses are extra commissions (trailing or upfront) for client investments above a threshold from a single adviser or group of advisers within a dealer group (a large group of advisers acting under one licence from a bank or financial institution). These must be disclosed.

Equity or dealer split: Wrap accounts and master trusts now split up the underlying fees in all manner of ways to encourage advisers to put more money into them. These must be disclosed.

The fastest growing form of remuneration for financial planners is collecting fees through wrap accounts based on assets under advice. I have a real problem with this, particularly where there are too many layers of fees and clients are simply paying away too much of their income.

Most wraps have three layers of fees: administration, advice and funds management, and typically these three add up to more than 2–3% depending on the size of the account. Given that the long-term average return from an income portfolio is 6–7% and from a growth portfolio is 8–9%, up to a third of a client’s returns are being paid away '¦ every year!

I have heard advisers say a total cost of 2.5% is a good client outcome.

The problem I have with wrap accounts is not just that they are still too expensive, but that it is not clear to the client where all the fees are going. The client must be told who owns the wrap account and who owns the adviser, and the relationship between the two.

Where wrap accounts were originally sold as a way of buying several products in an efficient manner, in 2006 wrap accounts have become the product in themselves. So an adviser might claim they are offering advice '” 'I prefer fund manager A over fund manager B', but then the advice given to every single client is to go into XYZ wrap account. The wrap account pays them an advice fee, possibly a volume bonus on the funds management fee and sometimes even an equity split on the administration fee. Too often the adviser has some form of ownership relationship with the wrap product recommended.

Is this fee for advice or a product commission? I have no problem with commissions on product sales; if you walk into a Ford dealer you expect to be sold a Ford and you expect the salesperson to earn a commission.

But our industry should do away with commissions for advice or even for the perception of advice.

When I started in the financial planning industry, I developed a love affair with Indian food and I remember a restaurant that used to charge on the basis of what you thought the meal was worth '¦ The restaurant went out of business because it attracted too many price-sensitive clients.

There is no perfect way to charge for good advice. If I were the only person in the industry who charged by the hour I would attract only the price-sensitive, who are likely to question every minute on my invoice. What if my advice is worth $30,000 a year in saved taxes, or $50,000 a year in additional returns but only took three hours of my time.

I have worked as an adviser in three environments: banking, stockbroking and accounting.

An accountant who charges by the hour often becomes a slave to time sheets, unfinished, unbilled work and unpaid invoices, unable to charge properly for growing a business strategic input or trust.

A stockbroker who is paid brokerage becomes a slave to the transaction, unable to charge for good ideas or research and finds as often as not the client will take the ideas and research and execute online.

A banker who earns a margin on a loan or a deposit becomes a slave to the size of the deal, regardless of the risk of loss or the wisdom of the transaction.

Good advice can be extremely valuable and as advisers we must find better ways to collect a reward for the value we add. And our clients must be crystal clear about who they are paying, and how much.

I have seen my industry debate this issue for 20 years. Most have made the leap from upfront commissions to ongoing fees for service, which is clearly in the client’s interests. But I fear that the waters are getting muddier, not clearer.

There are a lot of things we could do to clean up the mud but it is unrealistic to clean it all up in one go '” too many honest and competent adviser businesses have become dependent upon trailing commissions '” if a good adviser goes out of business by changing the playing field, then it will be the clients who will suffer.

But it is well overdue that we should finally switch off upfront commissions and I call on my fellow advisers to publicly state their disgust at Westpoint’s 10% upfront commissions and similar arrangements that exist in parts of the tax advantaged investment industry.

Next we should have a good hard look at wrap fees.

Tony Bates is a Certified Financial Planner and Principal of Bluepoint Consulting Pty Ltd (bluepc.com.au), which is independently owned and licensed. Bluepoint Consulting Pty Ltd charges clients a fixed monthly retainer and rebates upfront commissions. Some clients have negotiated a lower retainer in exchange for a long-term investment performance-based fee. Most clients own direct wholesale funds and direct securities where there are no commissions. Tony has closed more than $10 million in wrap accounts on behalf of clients and has yet to open one.