A case study: A few weeks ago, my friend D. decided he should start putting aside some money for the future.
A bohemian sort in his late 20s and without any savings, D. has no fixed career, let alone a pension. But things are going okay for him right now, and he thinks he can save £100 a month.
Not much, but a start.
D. also has the usual British aversion to money, which means he knows absolutely nothing about saving or investing and wrinkles his nose at the thought of learning more.
Now, I’d be the first to say he should take responsibility for his own financial future and start reading up on this stuff for himself.
In fact I’ve said so in the past – which is probably why instead of talking to me he instead went to a family friend, a financial adviser who’d advised his uncles.
I say ‘family friend’, but in other cultures, terms like ‘witchdoctor’ and ‘mafia hood’ might describe the same sort of relationship.
The financial adviser’s self-serving advice
Perhaps my bleating about the rubbish financial services industry has rubbed off on D. after all, because a few days later he asked me to the pub to discuss the advice he’d received.
It amounted to:
- No real explanation of his financial situation
- No grasp of what he was being sold
- Pages and pages of impenetrable small print
- Thick brochures on actively managed funds he didn’t need
- A direction to put his money into a ‘balanced fund’
- …with initial charges of 4%
- …and annual charges of 1.5%
- A numerical list of ‘special risk factors’ (presumably pointing to sub-clauses in the paper verbiage he’d trucked home)
- A 3% initial fee and 0.5% annual fee for the adviser
- His name signed next to it
I was dumbfounded, then furious. Aside from the fact it was going into an ISA, it was all rot.
My friend was set to throw away 3 to 7% of his hard-earned money (I say 3-7% because even I couldn’t tell from the paperwork whether the initial fees were cumulative, though I’m pretty sure it was 7%) as well as 2% a year to invest in a fund that would likely under-perform, and that he didn’t understand.
I urged him to get out, reassuring him that he wasn’t an idiot and saying probably half the people in the pub had done something similar – and then shuddering to realize it was true.
Who needs wine, women and Las Vegas when they’ve got a financial adviser?
So there you have it. Even when a financial adviser gets the opportunity to do the decent thing and teach someone about money – even when only a trivial amount is initially at stake – they spurn it.
If D. didn’t know me, then he’d have signed up a to a lousy plan. If it wasn’t for long-awaited changes coming in 2012 that will end this rotten sales commission once and for all, then as his regular contributions grew and his ‘relationship’ with the adviser deepened over the years, he’d have been robbed of thousands of pounds through fees, and ended up poorer in retirement than he needed to be.
And he’d probably be no wiser about it, either. That’s exactly what’s happened to millions of people who trusted their advisers over the years.
Three parting thoughts.
- Firstly, people who don’t know about money really don’t know about money.
Even when I made him understand the charges, D. still said to me 7% was ‘only £7 a month’. He wasn’t offended by the adviser taking his money for years to come for confusing him and passing off this shoddy investment, and he had no idea how much the fees would cost after compound interest
- Two, I’ve not done enough to make this stuff easy to understand, either.
I was going to point D. to my ‘simple’ article about index trackers, but after speaking to him I realised it’d be like pointing my baby niece to Wittgenstein’s Tractatus Logico-Philosophicus.
- Thirdly and most damningly – this guy was a family friend!
With leeches friends like these, who needs taxes or Las Vegas?
Articles elsewhere on financial advisers
- What the FSA ban on commission fees means for you – MoneyWeek
- Choosing an independent financial adviser - MoneySavingExpert
Note: I’ve changed or omitted a few details (not about the fees, but about my friend and the name of his financial adviser).
(Image by: Carniphage)
Filed under: Commentary
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hehehe – you’re spot on with the shocking self-interest of financial advisers. I was suckered as an impressionable pup in the late 80s to a) buy a house at the height of the boom, and b) despite a pep talk from my parents that “endowments suck for a single chap with no dependents”, to buy an endowment.
Buying was because I got fed up with needing to put down a ring of salt round my sleazy bedsit to keep the black slugs out, so I ignored the sage advice of two colleagues that the Lamont bust was imminent. 10 years I sold at a loss – housebuying is not a one-way ticket to riches if you buy at the top…
The endowment, however, was a shocking tale of doublespeak and important things left out, where I was led to believe, through three forecasts, called optimistic, and average and a pessimistic forecast, that I couldn’t lose over 25 years. They were all ludicrously optimistic.
From the quality of advice your pal got things haven’t improved in the intervening 20 years
At least I got my wedge back in a mis-selling claim, and the demutualisation of the life assurer before that gave a windfall that paid off 10% of the mortgage six years in.
@ermine – Thanks for your thoughts, and yes my young friend has had a lucky escape that others have been falling into for decades.
As someone who has been calling a housing bubble since 2004 and even when it bursts and brings down the world economy, STILL prices don’t meaningfully fall – I say don’t be too hard on yourself about buying before the Lamont bust.
House prices are borderline black magic.
@All – If you saw the very first version of this article put up about 3 hours ago, you may spot that I’ve extracted out 500 words.
A chum in the media urged me to ’start with the story’, and as some of you may know I’m desperate to write some smaller posts on Monevator (this was meant to be 300 words, not the 800 it is now or the 1,300 it briefly was!)
I’ll use half the extract for a short post tomorrow, and the other bit, which was funny but superflous, before the end of the month!
Thanks for indulging me, I try not to do this sort of thing too much with posts once they go live (unless I spot a spelling mistake!)
Amen brother! It’s a tragedy that IFAs have got away with (and got rich on) this scam for so long.
I’ve seen people like your friend D, who will:
a) sign up with some scam artist IFA who picks a crop of active funds
b) ignore their investments for the subsequent 5+ years
c) check them and discover they’ve done poorly
d) sign up with a different scam artist IFA who moves them to another bunch of funds
and bang there goes another 3% in initial fees. Makes me want to cry.
Not all financial advisers are bad or evil, but if you want to be financially independent, you HAVE to be independent.
There’s no way that can happen when you’re relying on someone else to make money for you. No matter how nice, cool friendly, or astute the adviser is.
Mat on: Connecting with Favorite Authors through the Internet
Ouch. 7% up front + 2% annual for a balanced fund is nuts.
But not surprising.
“I’ve not done enough to make this stuff easy to understand, either.”
I struggle with this same thing everyday, and it’s one of my big goals for this year: Make my writing accessible to a true beginner. Incidentally, I think what you’ve done here is an excellent way to go about it. Everybody can understand a story.
Mike Piper on: Asset Allocation with a 401(k) and IRA
@Lemondy – Yes, and the story is probably even worse when the new adviser chases performance with the new bunch of ‘hot’ funds.
@Mat – It’ll be less inherently conflicted here in the UK from late 2012, when sales commission will be banned… it’ll be interesting to see who survives on fixed fees alone, and how much they charge.
@Mike – I think accessible for a true beginner is going to be out of my range, except perhaps with a couple of special articles. To be honest, I’ve probably not built a readership who would put up with how simple I think you really need to be to really explain this stuff from ground zero, although your book might do it if they’d read a whole book.
Au contraire. I’d love an idiot’s guide to investing please!
Janet – I’ll see what I can do this month.
Not going to defend the outrageous upfront fees but to be fair to the leech he’s probably bound by law to give out all the documentation and to put D into a managed fund of some sort.
Bloggers and pals are less regulated than IFAs!
So whats D doing now? Back to wine and women?
As a US Fee-Only financial advisor I understand and share your outrage over your friend’s experience. There is a huge misunderstanding of financial advisor compensation, this is often to the detriment of individual investors. If I may, NAPFA is an organization of Fee-Only advisors here in the US, the link is http://ow.ly/Ugc2. Folks can search by their zip code and find local Fee-Only advisors in their area.
I have written two posts on financial advisor compensation in recent months, they are listed below if your readers are interested. Great post, thanks for sharing this story.
How is My Financial Advisor Compensated? – Fee-Only vs. Fee-Based
http://ow.ly/VZzX
How is My Financial Advisor Compensated? http://ow.ly/VZBV
Roger Wohlner on: Its 2010 Now What?
@Roger – Thanks for stopping by. Normally I’m a bit wary of links in comments, but both those articles of yours seem to do a very succinct job of explaining the differences in fee structure for U.S. readers, and I thank you for sharing them.
Yep, Roger hit it on the head. Whether you know a fair bit yourself or you know nothing at all, what you want to find is a fee-only advisor who uses low-expense index funds to track asset classes. They should charge no more than 1.5% of assets under management as an annual fee, at the high end. Their ongoing role in your financial life should include:
1. Managing the allocation of your money among several asset classes to reduce volatility, remove uncompensated risk, and match your changing goals as your life progresses.
2. Rebalancing your funds among the asset classes as performance variations push your allocation off target, in accordance with a written investment policy.
3. Keeping your taxes and investing fees as low as possible, preferably in concert with your CPA if you use one.
4. Advocating for your net worth by showing you how and why to save money, track spending and make better decisions.
Sometimes there is only one of these guys in town, if that. Their office will probably look shabbier than the rest. They almost certainly won’t own a yacht, though a few of their clients might.
Over the past 4 weeks I have seen about 10 financial advisors for my parents.
9 said index funds were no good and could give no compelling evidence of their theory, despite me telling them that 80% will not beat the market.
How can they be allowed to give such bad advice?
David de Souza on: Tax Rebate Scam Emails Continue – Beware -
Thanks for sharing your experience David – at least things will change a bit in late 2012.
Currently, IFAs have to offer a prospective client the choice of paying by fee or commission.
If the adviser was an FA (not independent like an IFA) then this is a different situation and they will be classed as ‘restricted’ advice after RDR and therfore will still be able to charge commission. It’s only IFAs that will be fee-based.
It sounds like this chap was an FA and not an IFA. It would be interesting to know which.
Advisers don’t have to charge VAT if paid by commission but if it’s a straight fee then, subject certain limits on having to register, VAT will have to be charged. This is good for goverment and bad for clients and the IFA, enforcing a new layer of cost not present with a commission payment.
Some insurance companies are gearing up for the potential contraction in the market place by bringing back their direct sales force – not necessarily good news for consumers as by definition they won’t be offering the ‘whole of the market’ and it’s likely to be commission only.
KPMG have suggested a third of the IFA industry will disappear. This may be viewed as a necessary cull but there is also the suspicion that the Banks – who dominate the Financial Advice market – will be the main benefactors (PPI policy anyone…?)
Out of interest, the majority of complaints are with banks:
http://www.ifaonline.co.uk/ifaonline/news/1533502/banks-dominate-fos-complaints-shame-list
Fees aren’t a panacea, as rarely is anything like this – RDR – without unintended consequences.
The danger is that ex-clients of IFAs end up at the bank or visit a direct sales force (run by an insurance company) who only charge commission and of course, aren’t independent.
It is a shame that the few spoil it for the majority. It is clear from the posts that there is a significant number of people who have not received good service and value from IFAs, yes properly qualified IFAs, not Sales people working for the Banks. I agree there have been IFAs who have ripped people off as in any walk of life, but this is a minority. The public really still haven’t woken up to the fact that it is the Banks and Building Societies and hence Life Insurane companies who have missold with poorly qualified ‘Sales’ people for years and years – the perception still unbelievably is they can be trusted. The average IFA in Yorkshire England earns £30,000 per year and believe you me the amount of hours that goes in to that to do the job justice and keep compliant is 50+ per week. Please let some common sense prevail – it is a minority of IFAs who rip people off and to be honest with the huge increase in regulation, exam requirements and fees to be an IFA, most of the crooks left the business 5+ years ago. Most IFAs I know genuinely have great concern for their clients and is often the case give free advice on a regular basis, yes free – how many professionals would do that?
It is a lack of understanding by the general public which us decent, moderate, caring IFAs are trying to change every day let alone try to earn a living. Commons sense please.
I’m sure there are some decent financial advisers out there, just as some criminals phone Crimestoppers when a granny gets mugged.
But I think the system based on commission is fundamentally flawed.
For instance, two-thirds of IFAs have never advised ETFs for their clients, despite them being a very cheap and easy way to construct a portfolio. And in two decades of reading the weekend papers quote financial advisers for recommended funds, I can’t actually remember them ever suggesting a tracker fund.
The reason is clearly that these products don’t pay commission.
Happily in 2012 all commission will be banned, and any excellent financial advisers out there will be able to charge fees for their worthwhile advice, without taint from the reputation of those who look for what kickback they’ll get before they think of their client.
There is another reason why ETFs have not taken off in the adviser community.
Platforms like FundsNetwork, Co-funds and Skandia (the big three) have been slow to offer them.
Advisers have complained about this and the reason is simple, the Platforms take commission from OEICs and UTs. This is a big part of their business model.
There are advisers recommending ETFs, but it’s a lot more difficult when some of the bigger players are not playing ball. The same can be said for Investment Trusts.
In reality ETFs will become far more sold in the future. But probably only by IFAs and not the banks that dominate the retail market.
As for pensions there’s no chance of using ETFs in a Stakeholder or Personal Pension, only in SIPPs. Therefore, by definition some IFAs simply won’t be able to offer them to their clients as they’re not the type to benefit from a SIPP and the associated charges that go with them.
Hi Thomas,
That’s fair enough, but very cheap and low TER tracker UTs are available through these platforms, and seem to be rarely advised. (Not in the example of my friend quoted here, various other friends in pension schemes, and also not in the weekend papers when advisers to a man recommend managed funds, with the very occasional final paragraph offering a nod to passive options).
Thanks for your insights into IFA perspective though, and for rounding out the picture.
@Thomas – You make some good points here. I would add that ETFs are relatively new to the UK retail market, unlike in the US where they have been around for years.
Also, It’s far from clear cut that ETFs and trackers are some kind of investment panacea. Sure, by going passive you cut out the risk that you’ll pick an underperforming manager, but there are issues like tracking errors to consider with trackers – they’re not all the same. And ETFs are only available on true wraps, not platforms like CoFunds, Skandia and Fidelity.
@TI I realise that a headline grabs readers – it grabbed me after all – but this one is a bit over the top. I’m not a leech or a swindler, but I acknowledge that here are many out there who are, particularly those working for banks. Like you, I rejoice at the introduction of RDR and look forward to much of the crap being weedled out of the IFA market at least, though as @Thomas says, the banks will be restricted and be able to accept commission.
Finally, to education. To my mind this is the primary aim of a good financial adviser. The difficulty though is making it profitable. No IFA is in it for a hobby, but to make money. That’s why I wouldn’t take on a new client with £100 per month to save. If I did, I would be out of business. Only the banks have the economies of scale to make that work, and they are the ones giving advice like your friend received. But that’s why I do have a website which seeks to explain basic financial planning concepts. It’s a work in progress, but a project I’m excited about.
Oops, there’s another finally. You’re right, the adviser in your piece is negligent at best. Your friend has no savings? Why did the adviser not tell him to invest in a cash ISA or something similar to build up a decent emergency fund? No sense in investing until that’s in place. That’s like financial planning 101, so basic it should be a given.
Keep up the good work, but lay off all IFAs eh? We’re not all that bad.
@Pete – Thanks for your extensive comments and insights, and good luck in your quest to explain investing to more people and to build a decent business as a financial adviser.
However I won’t be reigning back my views on advisers in the near future.
I’m one blog in a sea of largely industry-sponsored financial PR for the finance industry, most of which ushers investors straight into the hands of people who time and again are shown not to have their interests at heart.
If my post does nothing more than make a private investor ask more questions of the so-called ‘professionals’, then hopefully it’s made a positive difference.
There’s a whole slew of words arguing the other side of the case – I don’t think Monevator is going to bring down the industry (more’s the pity).
As I say, good luck with your own business. After the 2012 changes it might hopefully be possibly to put away the tar-stained brush, and peace will reign. Well, maybe!
@TI
Thanks for the good wishes, and do keep up the excellent work. I’ll do my bit at my end, but you’re right, I imagine it’ll be an uending quest to rid the world of cowboy IFAs and advisers.
Pete Matthew on: MM No 30 – Portfolio Building Blocks- CORPORATE BONDS