Financial advice: cost versus value

Some investors approach financial service providers such as Prudential directly because they believe they can get a better deal by cutting out the “middle man”, namely the financial adviser. Why do so many investors think this is to their benefit?

The answer to this question lies in the hefty debates and criticisms of the cost of financial advice in South Africa. There has been a strong regulatory and consumer media-driven focus on reducing the cost of advice and improving the quality of financial advice. However, there is seldom any reference to the value of the advice.

The roles and responsibilities of an independent financial adviser are specified by law

Advisers can make recommendations on a diverse range of services, such as life insurance, employee benefits, product advice, tax planning, estate planning, risk management, investment and retirement planning. We believe that investors will achieve better financial outcomes if they seek quality financial advice.

The Financial Advisory and Intermediary Services (FAIS) Act gives very specific guidelines to financial advisers. According to the Act, advisers should always act honestly, fairly, with due skill, care and diligence, and in the best interest of their client and the integrity of the financial services industry.

When it comes to the advice process, the Act stipulates that advisers must:

  • take reasonable steps to gather information about their client’s financial situation, financial product experience and objectives;
  • conduct an analysis based on this information; and
  • identify the financial product or products that will be appropriate to the client’s risk profile and financial needs.

Preparing adequately for retirement is one of the most important benefits of financial advice

According to research, the main benefits of receiving financial advice are:

  • peace of mind;
  • greater control over your finances;
  • helping to avoid bad investments;
  • making it easier to stick to a budget;
  • making it easier to save; and
  • improving retirement prospects.

Of all these benefits, comfortable retirement is of special relevance in our country. South Africans generally save far too little to generate adequate retirement income. This unfortunate situation is fuelled by the knowledge gap between consumers and the complex financial issues that affect them. Financial advisers therefore play a critical role in helping people save enough money for retirement.

Some risks of not saving enough

  • You could live longer than expected because medical science has improved.
  • You could experience an unexpected reduction in income due to poor market returns. Imagine living in Europe and having to retire now.
  • Inflation could eat away at the real purchasing power of your money.
  • You could be exposed to failing financial institutions and fraudulent schemes.
  • You may not be able to supplement your retirement income due to unemployment or ill health.

Because most of these risk factors are beyond our control, investors should embrace appropriate financial planning as the one risk-reducing measure that they can control.

The current economic instability makes financial advice more important than ever

Investors tend to seek financial advice at specific stages of their lives, such as when they are starting a family, paying off their bond or considering retirement. In addition, research in Australia has shown that demand for advice in that country is generated by two factors: the complexity of the financial markets and how important the decision is to an individual’s financial wellbeing. This means financial advisers should be able to provide tangible benefits to their clients, such as wealth creation and protection. They should help investors make an informed decision in a relatively complex and, at times, bewildering environment.

With the current global markets in turmoil, this is now more relevant than ever. Investors are nervous, but if they seek advice from a financial adviser, the adviser can provide them with strategies to safeguard their investments and assets. Advisers can help curb irrational investor behaviour in these difficult times and manage expectations more objectively. This can reassure investors and keep them from potentially making incorrect investment decisions.

South Africans are reluctant to pay for financial advice because it is hard to make the link between value and the fees they have to pay

Some South Africans are reluctant to pay experts for financial advice. These investors forget that they are paying for advice that comes with a certain level of expertise, commitment and attentive service. According to law, financial advisers are duty-bound to give advice that meets the investor’s objectives and to regularly review this advice.

These regulatory requirements ensure that the financial advice adds value by contributing to the security of the investor’s financial situation.

The way in which an adviser is remunerated is central to the question of value

The fees and the structure for payment varies between advisers. There are three ways in which advisers can be paid.

  1. Fees: An hourly fee is paid by the investor. The first meeting is often at the expense of the adviser. From there on, the investor pays the hourly rate or a pre-agreed fixed sum.
  2. Fees that are “built into” or structured alongside any product fees – also referred to as commission: This is the charge that a financial services provider pays to the adviser when the client invests in the provider’s products. This could include an initial sum as well as a “trail fee”, which is a smaller amount that is paid regularly to the adviser while the investor remains invested in the product.
  3. Fees and commission: Some financial advisers offer a combination structure. This means the investor could receive some of the commission back, normally reinvested into the product, or alternatively offset it against the fee.

The debate over whether financial advisers should receive explicit fees linked to advice services rendered or commission is always a heated one. However, it becomes a real problem when any fees or “additional” charge discourages people from investing.

Therefore, we believe we need to help potential investors understand the role and value of advice. Financial advisers offer a valuable service and they deserve to be reimbursed in a transparent and open way. Of course, it goes without saying that financial advisers should be qualified, professional and give appropriate advice.

Internationally, there is a trend away from commission-based remuneration

The Retail Distribution Review (RDR) is a piece of legislation in the UK designed to break the link between adviser sales and their remuneration by product providers; that is, commission on products sold. According to the Financial Services Authority (the UK regulator), commission leads to advisers acting as agents of asset management companies, instead of acting in the best interests of their clients.

The regulator believes that when advisers are not paid directly by investors but, instead, receive commissions and other distribution fees from the providers of financial products, their recommendations are biased towards particular financial products.

Only time will reveal whether any change in the UK will be a successful model. The Financial Services Authority’s new rules include the following prescriptions (many of which will shine a spotlight on the value of advice):

  • By the end of 2012, all financial advisers must have a qualification equivalent to the first year of a degree.
  • Advice must be truly independent and reflect the investor’s needs.
  • Clients must be able to understand the service they are being offered.
  • Commission-bias must be removed from the system and investors should know upfront how much the advice is going to cost and how they will pay for it.

A focus on value, not cost, will enable investors to reap the benefits of professional advice

When the benefits of financial advice outweigh the expected costs of the advice, investors will be more willing to engage the services of a financial adviser. We want to encourage this form of rationality among investors so that they can benefit from quality financial advice.

At the same time, financial advisers should be properly qualified and ethical in their treatment of their clients’ important life decisions.

Even though it’s hard to quantify the value of advice, it should give investors a better understanding of their financial situation and more knowledge about investment options. This will give them confidence to achieve their lifestyle and financial goals as well as to prepare for retirement. There is still a considerable focus on reducing the cost of advice to investors in South Africa. We believe that to effectively address the savings crisis in the country, there must be a stronger focus on the value side of the discussion about financial advice.

Sources: Role of advisers within the financial services market, A. Mckee, 2010; Galaxy research, March 2007; The value of financial advice, Actuarial Society of South Africa Convention, November, 2007; Investor reaction to financial turmoil – can financial planners help? A.Z. Ali, 2008; IFSA/TNS Investor sentiment research, November 2006.

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