A decade ago I wrote here about the way financial advisers are paid. I told you how, instead of giving you a bill, your adviser is allowed to sell you investment products in exchange for a commission from the product provider plus a cut of your assets every year for as long as you continue to hold those products. So if you buy an investment fund from an independent financial adviser (IFA), he will receive a payment up front and then another payment every year, whether you ever have the good fortune to come across him again or not. All these payments will come out of your money — you just won’t know much about it.
Think of it, I said at the time, as like buying a house through a search agent, but instead of just paying him a fee for finding the house, you also pay him another fee equivalent to the costs of his family holiday in Cornwall for every year you live in the house thereafter. But it gets worse. Now imagine that the agent who helped you buy your house didn’t actually guide you to the best house for your purposes. He knew of several others that were both cheaper and better, but he didn’t show them to you for the simple reason that his fees would have been lower.
That’s exactly what has been happening in the financial industry for years: all products pay advisers different levels of commission, and advisers tend to push you into the ones that pay the higher commissions to them. They will tell you this just doesn’t happen — that there is absolutely no ‘commission bias’ at all in their business. But that’s nonsense. Those in any doubt need only look back at the sorry parade of financial products that UK investors have ended up holding over the years or note that investment trusts — which have a long history of outperforming other types of funds, but which come with no commission — make only rare appearances in most portfolios put together by old-style IFAs.
For me, however, final proof came in a comment under an article on the trade magazine site Moneymarketing.co.uk. It was a short line in a longer comment but it summed up exactly what has gone wrong in the financial industry. It came from an adviser who has recently shifted from the old commission-based model to one in which he charges transparent fees. ‘Interestingly (and I’m not especially proud of this),’ he said, ‘since moving to a fee-based model I notice that my advice has changed somewhat in the clients’ interest.’
So there you have it. Whether he did so consciously or not, and despite being labelled independent, he in some cases recommended products to his clients on the basis of the commission payments he would get from providers, rather than on the basis of what might make them rich.
Still, I am here to bring you good news today. The reason the repentant adviser I mention above moved to charging fees is because in the ten years since I wrote that last article something has changed. Both the authorities and the many good client-focused advisers out there recognised the need for change, and have managed to force it through. At the beginning of next year new rules come in under something called the Retail Distribution Review. It sounds dull as ditchwater, I know, but it will force all the commission payments that have been steadily destroying your savings out into the open. From now on you will know exactly how much you are paying your adviser because he will have to either get a cheque out of you or obtain your explicit agreement to keep helping himself from your funds. And there is nothing like transparency to cut costs.
Better still, now that your adviser is going to be charging in the same way as a professional, he is going to have to be trained in much the same way too: educational standards are to rise across the board and those not up to scratch with their qualifications have until January to get themselves sorted.
So what does all this mean for you? It doesn’t necessarily mean that you will end up with better advice than you might have had otherwise. But it does means that the financial advice you do get should cost less: you’ll pay more in fees up front but much less in commissions over the life of your investment. At the same time the investments you end up with should come with lower fees — and in the world of funds, low costs have a long history of being one of the better predictors of out-performance.
You are going to hear many complaints about the RDR from within the financial sector over the next few months. You will be told in particular that it will create an ‘advice gap’: those who can’t afford up-front fees will end up not getting the advice they need. But I think this is nonsense. The fact is that if you don’t have the cash to pay £150 for an hour with an educated IFA, you are in no position to pay them more via their commission take. You probably also don’t need financial advice as such: you need to pay down your debts and save. That’s a different thing.
The RDR isn’t going to make things perfect. But it won’t make them worse and it should make the outcomes for most people rather better. And you know what? That’s probably the best you can hope for from a reform to the financial sector.
Finally, one word of warning: old habits die hard. If your IFA manages to flog you any products before the beginning of next year, the new rules will allow him to keep taking ‘trail commission’ from them until you sell up. The result? There has, as FT Adviser puts it, been ‘a rise in advised sales of retail investment products that pay recurring trail commission ahead of RDR’.