Anyone who has been a regular reader of this column will
by now have gathered the importance of taking financial advice
and having a proper financial plan in place for the future.
This means allocating resources in the right proportion and
in the appropriate financial vehicles for short, medium and
long term goals. These have to be achieved mainly via financial
instruments which invariably involve charges. These charges
are often a mystery and not clearly understood.
There is no such thing as a ‘free lunch’
The first thing to understand is that no service whatsoever
can be free. It may appear to be so. For example, a savings
account may pay a given rate of interest and the account may
not bear any charges. What you do not see of course is how
much the bank is making on the money you are lending. For
example, you may receive a rate of 5% but the bank could be
lending it at 10%. If you were able to contact the borrower
and lend directly you would make the extra 5%. So effectively
you are paying a 5% charge. Of course in reality it would
be difficult to locate a suitable borrower. And if the borrower
defaulted you would be out of pocket whereas by dealing with
a bank the latter would absorb any bad debts. So you are paying
for an essential service and there is a price for that service.
How does this work for financial advice?
How do financial advisers get paid? I am often asked this
at a first meeting, which is my own fault for assuming that
people know and for not mentioning it earlier! I am always
tempted to say that I work for nothing and that my work is
purely charitable. However, I cannot keep a straight face
so have to explain that I am not paid directly by the client
but via commissions and fees paid to my company by the various
institutions to which we refer our clients. This used to be
the case universally but in western countries financial advisers
are now becoming more generally paid on a fee basis. Fees
may be based on an hourly rate, from perhaps $100 an hour
for a junior financial adviser to $500 an hour for a wealth
manager serving high net worth clients. This is how accountants
and lawyers can also be paid. Alternatively there may be an
annual charge.
Why would anyone wish to pay fees?
The reason is that financial planning is now taken more seriously
in the West and people are prepared to pay for sound financial
advice. There is also a greater degree of regulation in the
West and advice is more likely to be completely independent
when commissions are not involved. My group would like to
move in this direction but the ‘offshore’ world
is very different from the ‘onshore’ world where
people generally stay in one place and can use the same accountant,
lawyer or financial adviser for life. Expatriates are not
used to paying fees for such services and would be unlikely
to welcome their introduction. This would certainly be the
case in Bali. Also, the products available to expatriates
generally have charging structures that are geared to paying
commissions and would have to be revamped if fee paying became
the norm. So while fees are not payable by expats they certainly
pay them in kind via charges in the products they invest in.
What are these charges?
They vary considerably from product to product but are generally
comparable from one institution to another. The charges have
to be sufficient to cover all the institution’s expenses,
overheads, marketing costs, commissions to intermediaries
and of course sufficient to enable them to make a profit,
without which they would not remain in business. Many have
not and have fallen by the wayside in recent years. Fortunately,
the legal structures are such that investors are still protected.
Charges on a lump sum investment may be from 5% to 7% initially
plus ongoing annual charges of 1% to 2%, not counting annual
fund management charges which can range from less than 1%
to over 3% for highly specialised funds. A larger portfolio
may not have an initial charge but would have annual charges
in the region of 1.5% to 2.5%. Added to this would be an adviser
fee for larger investors. Because life insurance takes more
time to sell and the underwriting requirements can mean that
a long time elapses from the sale to the payment of commission
the sales cost is quite high and can amount to as much as
the first year’s premium.
What about regular savings and pension plans?
These can indeed be quite expensive for the smaller investor.
Again this is related to the time and expense involved in
selling the product but also to the high cost of administering
such plans. This is why I would now rarely advise anyone taking
out such a plan unless they can comfortably save at least
$500 a month and have sufficient reserves and certainty of
future income to ensure they can maintain their commitment
to the end of the plan. Such plans are an essential part of
financial planning unless other substantial assets are held.
Stopping contributions or surrendering a plan in the early
years can however lead to receiving less than has been invested.
This is not a reason for not starting a retirement plan but
a commitment to the plan is essential. There are alternatives
to contractual savings plans but they tend to be fairly expensive
because they are costly to administer and people rarely keep
them going for very long. In other words, when access is easy
it is too tempting to use the funds for reasons other than
intended, with the consequence that essential long term needs,
such as adequate provision for retirement, are not being met.
So what is the answer to the question in the title?
I guess it has to be that having good financial advice is
both a luxury and necessity. Corners can be cut, but the same
adage applies in this field as to the person who decides to
become his own lawyer! There is a price to be paid, albeit
indirectly through charges, but the field is no longer one
in which the amateur can play (what happened to all the day
traders after March 2000?!). Good advice is costly in any
field, whether it is legal, accounting or personal finance.
But not taking advice can be even more costly!
Colin Bloodworth is a senior financial adviser with Financial
Partners International. The views expressed are his own. If
you have any questions relating to personal finance you may
contact him at 021 520 8099 or colin.bloodworth@financial-partners.biz
