If you engage a financial advice business in New Zealand to provide investment advice, they'll almost certainly charge you asset-based fees.
If you have an investment portfolio, they'll charge you a small percentage of your investment portfolio to provide ongoing investment advice and to implement the advice.
It often starts at around 1%, and then decreases as the size of your portfolio increases. For example, it might be 1% for the first $500,000 and 0.8% for the next $500,000, and 0.6% for every dollar thereafter.
So if you have an investment portfolio of $500,000, you'll be charged $5,000 per year. If your portfolio is $1 million, you'll be charged $9,000 per year. If it's $1.5 million, you'll be charged $12,000 per year.
I'll be frank:
I can't stand asset-based fees.
Can't stand 'em.
It's one of the reasons I set up my own financial advice business rather than join an existing advice business.
The only way I can feel comfortable providing financial advice as a professional service is to charge in the same way as other professionals such as lawyers, accountants, doctors, and dentists charge. On the basis of time or fixed fees.
I'm not putting financial advisers down by saying this. Most of the advisers I meet are smart, dedicated, well-intentioned people. They provide good advice. I like them.
But I believe in the power of incentives. And I don't like the incentives associated with asset-based fees.
Asset-based fees create unnecessary conflicts of interest
Asset-based fees are better than commission. I'll admit that. Commission creates an incentive to sell to people rather than advise people.
But that doesn't mean asset-based fees are free from conflict.
Think about it this way.
Let's imagine you have a windfall of $400,000. It's quite likely the best thing you could do with that money is repay your mortgage.
But an adviser charging asset-based fees won't receive any remuneration from that $400,000 if you repay your mortgage.
They might, however, receive $4,000 (ie, 1% of $400,000) per year, if you invest that money into financial assets.
If you don't think that could influence advice, we have different ideas about human nature.
Another conflict of interest is that it can result in an adviser encouraging you to save more than necessary.
Don't get me wrong. Saving for retirement is important.
But there is such a thing as saving too much. Or focusing too much on money and building financial wealth, rather than enjoying our life in the meantime.
If you're in an excellent financial position, the best use for your money might be to buy a $500,000 Ferrari 488 or a $1 million yacht. It would depend on your values and priorities, and a good financial adviser should be able to help you consider the consequences of this decision and how it fits in with all of the other things you want to achieve in life.
But how do you think that advice will be influenced if that $500,000 or $1 million comes out of your investment portfolio, and the adviser stands to lose $5,000 or $9,000 of annual revenue?
People who would benefit from financial advice end up being underserviced
There are more than 4 million people living in New Zealand. Only several hundred thousand receive comprehensive advice from Authorised Financial Advisers.
People would benefit from receiving financial advice. At the very least, it will protect them from money vampires and paying unnecessary fees. Good advice will also give them confidence about their financial futures.
The size of this disparity - between Kiwis who would benefit from advice and Kiwis who receive advice - is enormous.
And the biggest reason, in my view?
No prizes for guessing it. It's asset-based fees.
If advisers can provide essentially the same service to someone with a portfolio of $50,000 and a portfolio of $1 million, but pocket almost 20 times the amount in annual fees to service the latter, you can guess which type of client they will aim for.
Asset-based fees are the reason most advisers don't want to work with clients with portfolios of less than $200,000 or $300,000. Even though these clients would benefit from enormously from receiving financial advice.
The amount some people end up paying financial advisers is insane
Personally, I don't believe someone with an investment portfolio of $1 million should be paying someone in the order of $10,000 per year to manage their investments.
I've seen clients pay advisers tens of thousands of dollars per year for services like this.
It. is. not. that. hard.
I have a background working with professional trustees. In this context, the discrepancy between value and cost become especially clear.
For some reason, people can be very sensitive to the price they pay the professional trustee of their trust. It might be in the vicinity of $500 to $1,000 per year.
But sometimes, trustees have to make really tough decisions. There's a lot of risk involved. They work hard for the money they charge.
Quite often, the assets of the trust might include investment assets.
While the trustee is working extremely hard for their fees, the investment adviser is often charging many times what the trustee is receiving, with their fees receiving little to no scrutiny.
Trust me. I've worked in both positions. In almost every case I've seen, the trustee role is harder and riskier than the investment management role.
If you're paying your financial adviser $10,000 per year, find out how much time they spend on you personally. Translate that into an hourly rate, and it will almost certainly be higher than the hourly rate the most expensive lawyer or accountant would charge you.
Am I bringing industry into disrepute by saying this?
I'm an Authorised Financial Adviser (AFA). As such, I have to adhere to the Code of Professional Conduct for Authorised Financial Advisers (the Code).
One of the code standards is that an AFA "must not do anything or make an omission that would or would be likely to bring the financial advisory industry into disrepute".
I'm pointing out the issues associated with how most AFAs are remunerated.
I don't think I'm bringing the industry into disrepute by doing this. If anything, I think this remuneration structure, and the fact that it's the dominant structure, brings the industry into disrepute.
What do you think?
- Conflicts of interest when providing advice
- No one is unbiased. No one is free of conflicts of interest.
- "The dirt on coming clean" (or: "the perverse effects of disclosing conflicts of interest")
- Exploring conflicts of interest (podcast episode)
Why Fairhaven Wealth charges fixed fees (video):