Advice charged by the hour will always be better

The advice scandals at CBA and Macquarie may be costly ... but they highlight how consumers must seek out advice in future.

Summary: As CBA and Macquarie deal with the results of past problems in their financial advice departments, it’s timely to consider how valuable advice is and what it should cost. Financial planners can help clients diversify, manage volatility and access securities that are difficult to obtain otherwise. But 1% or more of assets is a high price to pay for that service.

Key take out: The best fee structure for a financial planner should be charging per hour, not taking commissions. Make sure you know exactly what fees are being paid.

Key beneficiaries: General Investors. Category: Strategy.

During the week I received a surprise letter addressed to the estate of my late mother. Mum died more than a decade ago and it’s a long time since we received any mail to the estate. 

This was a letter from Macquarie which, using legal terms, was asking whether I had any problems with any advice that Macquarie gave to the estate more than a decade ago.

I certainly had no problems because we didn’t actually ask for any advice – it was a straight liquidation of Mum’s estate. But that letter underlined a number of important issues. The first one is that if there had been any bad advice (and hindsight is a wonderful thing) maybe I would be now tempted to look for some form of redress.

Against that background I also read that Commonwealth Bank had appointed Maurice Blackburn, Shine Lawyers and Slater and Gordon – three of Australia’s toughest consumer lawyers – to provide free legal advice to customers who take part in CBA’s Open Advice Review program. These tough law firms will, according to CBA, act as so-called “independent customer advocates”.

All this simply underlined to me that Commonwealth Bank, Macquarie and others could find themselves with considerable liability given the extent of the canvassing and the process to deal with the claims. Certainly in the case of CBA, chief executive Ian Narev has stacked the odds against his bank to ensure that there could be no complaints of unfairness. However I believe it was a good decision. The actions of the CBA people were appalling and in bad situations like this, face up to the facts and take the loss rather than let it fester as previous boards of CBA have done.

But, as well as receiving the Macquarie letter this week I had a discussion with a reputable financial planner who charges a percentage of the assets in client’s portfolios – I think it is about 1%. These two incidents led me to ask: “How valuable is advice and what should you pay for it?” 

Commissions vs flat rates

Traditionally advice came from brokers and bank managers. Bank managers charged very little and brokers charged a commission on buying and selling securities. Both, in hindsight were very cheap but their advice was restricted. The bank manger did not go much beyond bank deposits. The broker did not go much further than shares.

So then came the financial planners who usually charged on the basis of a percentage of the assets in the portfolio and also often received a commission from the makers of the actual securities they sold to you.

This was a highly rewarding exercise and led to considerable conflict of interest and abuses particularly when the advice caused clients to borrow money and take high-risk positions that generated big fees for the financial planner. Since then there has been a much better and more transparent fee structure introduced.

In my mind the best fee structure for the financial planner should be to charge per hour exactly as accountants and lawyers do. And certainly that’s what I advocate if anyone asks me about fees for financial planners.

How planners can add value

It is much better to pay for the time you are buying. In our discussion the financial planner explained that he believes he delivers value on a number of fronts. Firstly he holds the client's hand on a regular basis. He says that as clients get older they can become more jittery and need someone to talk to on a regular basis. Without that regular consultation they are likely to panic and sell out at low prices in a crisis. This financial planner’s argument is that this service is going to be even more necessary in the future because of the likely volatility of the markets as predicted by the Reserve Bank.

Secondly the financial planner who is part of a large investment house says he can get access to securities that are difficult to obtain for a person acting on their own. In particular there are two areas where it is hard to access securities. First are overseas investments. Investment groups like Templeton and Platinum offer access to overseas markets but specialist funds are harder to obtain. For larger clients assembling an overseas stock portfolio requires expert advice.

I will be attending the Eureka Report International Investing Summit Conference on overseas investment on November 25 (click here to find out more and register). I will come back to you with what I told the conference and with some of my discoveries. Look forward to seeing you if you can make it.

A separate area where the financial planner believes he has unique products is in is infrastructure where (foolishly in my view) many infrastructure projects are tied in with institutions instead of going to the public and self-managed funds.

And the final area where he says he delivers value is in diversification. There are no longer “safe assets”. We have seen a big fall in the real value of short-term deposits because of lower interest rates. In the US in the next two years we are likely to see interest rate rises of around two per cent, which will cause losses in the longer-term bond securities. There may be a gap but in time the higher US interest rates are likely to come to Australia. Hence the financial planner believes diversification is essential.

Know your fees

Nevertheless, I still believe that 1% plus of assets is a high price to pay for that service, particularly where there are trail commissions floating around.

But most importantly you should know exactly what fees are being paid because the only person who can determine whether it is good value or not is the person paying the fees – that’s you. In those dreadful crashes of recent times people took incredible risks by effectively borrowing money to generate fees for financial planners. That’s why I think the level of damages is going be high given that the CBA is bending over backwards to be “fair”. 

There is another area of fees that is rarely talked about – home mortgages. Very rapidly the percentage of home mortgages negotiated by a broker is now close to 50% of the market. Brokers normally receive a commission of around 0.65% and they also receive a trail commission on the mortgage as well. Banks are paying these high commissions because it lowers their processing costs and of course they get the business. In the process it is reducing the economics of the branch and groups like the AMP are reorienting their whole advice structure so they first try and get the mortgage from a client which gives them a high base fee and then they offer better terms for superannuation and other investment products.

In a strange way we are moving to a situation where financial advice will be linked into the home mortgage commission structure. This is of course what Mark Bouris, executive chairman at financial services provider Yellow Brick Road, is doing.

So again when you are negotiating in the area of advice be aware of the power of the mortgage. Of course whether you pay a lot or very little if the advice is good and you achieve your objectives you will be happy. If the advice is bad or does not turn out as expected then you have over paid for it even if on the surface it looks low cost.

One final point: Always be alert to when advisers change 1% a year for what are effectively index products.

Remember when you are investing in interest-bearing securities often you are better not to operate in a fund where the adviser gets commissions because bank term deposits’ government guarantee is not available for the pool funds because it is limited to $250,000.