How investors can be receiving costly, confused and conflicted advice – and how to fix the problem

Why do you save and invest money today instead of spending it?

I suspect, like most people, it’s to provide financial security and peace of mind, ensuring that standards are maintained during your retirement years. Makes sense.

However, for those engaging with financial planners, there is a significant problem that you may be blissfully unaware of.

The most common method of charging is based on a percentage of your investments – an approach that can seriously damage your wealth. Why, I hear you cry!

In South Africa, you would typically expect to pay a fee of 1% for the ongoing planning advice and on average 1% the ongoing investment management.  So, 2% for the full round-trip.

So, imagine that your investment portfolio has a value of R1m. The financial planner charges you the industry average fee of 2%, which means your fee to the financial planner starts at R20,000 per year.

But here is the rub……

If the value of your investment portfolio increases to R2m, your fee to that financial planner is now R40,000.

But why?  What’s changed aside from the portfolio value? Have the services you receive changed? Did your financial planning requirements just become more complex?

Remember, in most cases the financial advisor isn’t even managing the money for you – they are simply ‘outsourcing’ to a third-party so it is a stretch to believe that their fees should in any way be linked to the value of your portfolio.

No. To be clear.  The method of charging a percentage linked to the value of your investment portfolio is nothing more than a tax on growth. Over your lifetime you will see (well, actually, part of the issue is people don’t see it) a significant transfer of wealth from your family balance sheet to the balance sheet of the financial planner.

In more practical terms that difference could buy a brilliant education for your children, some pretty punchy holidays, or may just mean you could retire earlier.

The four key issues with this charging model are:

1) Cost

The compound effect of a percentage fee of your money can be very significant, particularly with larger portfolios over longer periods of time. The consequence of these costs is not trivial and can make a real difference to the success of your retirement plans and investment goals.

2) Cross subsidy

In simple terms, the more money invested, the greater the fees paid to the financial planner. This could mean that a client with a R1m portfolio is paying R10,000 each year in fees and the client with R100,000 invested pays only R1,000, often for a similar level of service.

So the financial planning firm may end up using fees from one set of clients to subsidise another set. 

3) Conflict of interest

On a percentage-based fee model, the financial planner may receive an immediate pay cut in their fee income if money is removed from the invested portfolio. So, typical lifestyle events such as making gifts to children, buying property or investing in a business could lead to a reduction in the manager’s fee revenue.

As a result, there may be some resistance from the financial planner to support a recommendation to sell assets within the portfolio.

4) Contingent charging

By linking financial planning fees directly to a percentage of the money invested, the financial planner will be paid only if you invest money. No investment means no fees. Alternatives such as paying off debt or keeping a healthy cash buffer may be overlooked, as such options would not generate fee income for the financial planner.

The UK regulator, the Financial Conduct Authority, has expressed concerns over contingent charging and the need for financial planners to sell investments in order to be remunerated.

Tell me about a fairer way!

At Capital Asset Management we have been charging our clients a flat retainer fee for several years and are spearheading the movement for change in the UK.

Let’s imagine you have £1million. You engage a financial planner, and they charge you a flat-fee of 2% for financial planning and investment management advice.

The fee you agree is £20,000. However, as that investment portfolio grows over time, your fee to that financial planner remains the same.  

We believe that flat all-inclusive fees are more transparent and fairer. Our clients know exactly what they are paying when it comes to the financial planning advice and investment management from us. Nothing is hidden and there are no extras.  

It is important to note that this isn’t about being cheap, or a ‘race to the bottom’ on fees. This is simply about delivering fair value to clients seeking valuable, professional support.

I am excited to see the Doshguide team bringing their skills and expertise to this movement for change in South Africa, and I am delighted that more and more people will begin to receive valuable, expert, financial advice from market leading practitioners.

Alan Smith is CEO of financial planning firm Capital Asset Management, based in the UK. He can be found on LinkedIn here

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