As far as I'm aware, Fairhaven Wealth's fixed fee remuneration structure is the cleanest of any financial advice business in New Zealand, if not the world. I'm not aware of any other financial advice business that charges in a way that aligns its interests as clearly with the interests of its clients. In this article, I explain why.
While planning Fairhaven Wealth, I gave a lot of thought to its business model. Specifically, how I could charge for my services so that I was remunerated for my time and the risk involved with providing my services.
A huge part of the equation was how to charge in a way that aligned my interests with the interests of my clients, to make it as easy as possible for me to provide the highest quality advice I could.
On top of this, I perceive that a huge part of what I'm doing is helping clients deal with the biases that can lead them to act against their best interests. I don't want my remuneration model to be doing this while taking advantage of these biases at the same time.
In effect, I have been wearing both my "capitalist" and "consumer advocate" hats. The business needs to be financially viable. And as a professional adding value to my clients, I deserve to be remunerated.
All remuneration models have conflicts of interest
One thing I need to stress is that all remuneration models have conflicts of interest. As I discuss later, this is true even when charging based on time or charging fixed fees. This issue of conflicts of interest isn't unique to financial advisers.
I also want to stress that although the remuneration structures I discuss create conflicts of interest, and creates the potential for less-than-ideal advice, I am not in any way suggesting that advisers with these conflicts are giving inappropriate advice. Many, many advisers are remunerated in this way and provide fantastic advice.
I simply have a personal prejudice towards avoiding temptation rather than resisting it.
This is a matter of looking at the conflicts of interest that each method of charging clients creates and seeing whether they can be managed adequately. (And as I've discussed before, I don't think managing a conflict via disclosure is enough.)
Personally, commission is out of the question. I'm not comfortable with being paid by product manufacturers. I don't want the incentive of recommending inferior products simply because they pay more commission.
I'm providing services to my clients, not the product manufacturers. It should be the clients and not the product manufacturers who pay me.
Many advisers don't receive commission in relation to investment products. And in fact, in Australia, there is a blanket ban on commission ("conflicted remuneration") that covers most types of financial product, with the exception of insurance.
I'm going to go further than most advisers and refuse commission in relation to insurance products. There are still major conflicts with receiving commission that I'm not prepared to accept. For example:
- In most cases, commission to the adviser is higher for the first year than subsequent years. This creates a financial incentive to recommend a client move ("churn") from one product to another, simply because the first year commission will be higher than I otherwise would have received.
- It creates an incentive to recommend more insurance to a client than might otherwise be necessary.
- If I'm only being remunerated for insurance advice by commission, there's no incentive to consider a client's financial situation and provide them with the still-valuable advice that their current arrangements meet their needs. And in fact, there might be cases where the client has more insurance than they need. If I'm currently receiving commission from their existing arrangements, there is a disincentive for providing this advice.
So - no commission. At all. It might mean that I earn less than my peers who receive commission. So be it.
This type of fee arrangement has many different names. They are commonly referred to as fees relating to funds/assets under advice/management (FUA/AUA/FUM/AUM).
In simple terms, if an adviser is charging fees in this manner, they are charging a percentage of the value of your investment assets they are advising you on. If they are advising you in relation to investment assets valued at $500,000, and are charging a straight percentage of 1% per annum, they would be charging $5,000 per annum.
Charging in this way is exceptionally common. It's almost unheard of for an investment adviser to charge in any other way.
Just because this is the status quo, however, doesn't mean it’s the best way of doing things.
Jim Dahle, who runs the site “The White Coat Investor”, articulates this clearly in an article that explains why he considers these types of fees as “the second worst way to pay for advice”.
Dahle concedes these types of fees aren't “as bad as commissions, since the adviser is being paid directly by your and only for their advice and service. So it is truly fee-only, but there are still… significant problems with this model”.
Some problems include:
- These types of fees still create significant conflicts of interest.
The adviser only gets fees relating to funds that are under advice. So there’s a disincentive, for example, to recommend liquidating financial assets to repay debt, even if this is the best thing for the client to do. Because that would reduce the asset base upon which their fees will be based.
- In most cases, these fees are paid automatically. This “has the effect of [anaesthetising a client] to just how much [they] are paying”.
Dahle notes that advisers who charge on this basis “might argue that investors really want their fees out of sight because it is psychologically too painful to pay them upfront, and if they quit paying them, they'll be worse off due to their behavioural mistakes”. He thinks this argument is “patronising”. I agree.
(Although Dahle concedes that “it may be true for many investors with little knowledge and poor discipline”, and I agree with this too.)
- Advisers who charge on this basis have little incentive to help clients who don’t have much money. If you charge 1% per annum, why pursue clients with only $50,000 ($500) when you can get so much more from clients with $500,000 ($5,000)?
Like Dahle, I believe that those clients with little to invest are often the clients who would benefit the most from good quality advice.
I find these arguments compelling. And for these reasons (among others), I won't be charging on the basis of asset-based fees either.
Where to from here?
This essentially puts me in the position of charging on the basis of time spent, or charging fixed fees for certain types of services. Or a hybrid of the two.
No way of charging clients is perfect. Time billing and charging fixed fees have their own implicit types of conflict.
For example, if you charge on the basis of time spent, you might have an incentive to spend more time on a task than necessary (ie: mow grass with scissors). And if you charge a fixed fee, you might want to spend less time on a task than might be necessary. You can dig deeper and find other potential issues as well.
But as I consider how I want to run my business, this is how I feel most comfortable while wearing my "consumer advocate" hat.
My preference is to charge fixed fees. It gives me and my clients' certainty about what the service will cost. It encourages me to develop efficient ways of operating. And compared to charging on the basis of time, it's less bad for the soul.
It might not be the most effective way of maximising my income, at least in the short term. But if I wear my "capitalist" hat, I'm confident that aligning my interests with those of my clients is a clear competitive advantage, and is the best way of ensuring that I provide excellent quality financial advice and build a committed, loyal, base of customers and referral partners.