If you’ve used a financial adviser in the UK over the past 10 or 20 years, you may have noticed that something quite significant changed in 2012.
Getting financial advice pre-2012 may have felt very different.
How expensive did financial advisers use to be?
For those of you that didn’t seek financial advice before that time, I’ll quickly summarise the process. The following applied to ‘commission-only’ financial advisers, also known as ‘fee free’ advisers.
- You would give the adviser a call, and they would hold an initial consultation.
- In this consultation, they would understand a bit about your background, along with what your risk tolerance and time horizon is.
- They would go away to take some time to form an investment plan for you.
- You would be brought back to their office and they would talk you through a proposal.
- This would typically involve investing your money into a small selection of mutual funds.
- If you agreed to go ahead, they would take care of some of the administration for you, requiring you only to make payments to the investment providers, and signing some documentation to accept the advice and agree that you feel you have been informed of all the key facts and risks of the plan.
- The financial adviser would not raise an invoice for you – they got their money from the other side (the investment providers).
This felt like the best of both worlds. Consumers were able to seek out advice on complex financial matters without being deterred by needing to pay professional fees (which can range between £500 and £5,000 on the average piece of advice). Financial advisers still made a good living. It seemed like an ideal setup that maximised the amount of ‘public good’.
Why did the FCA want things to change?
The FSA (the UK Financial Regulator at the time) did not like this business model at all. It was the last element which caused them to become concerned.
The issue was that a Financial Adviser, particularly an independent financial adviser, is duty bound to provide advice that is in your best interest. Independent financial advisers are required to look at the ‘whole of the market’ and therefore the products they are recommending should be the most suitable for your circumstances.
How then… could IFAs explain their recommendations of expensive mutual funds with 3% initial fees and 2.5% annual management charges thereafter?
Similar, low-cost funds could be accessed for 0% initial fee and less than 1% annual management charges.
In these cases, seeking out an IFA led to the consumer being introduced to a fund which would:
a) Skim several percent off their portfolio before an investment was even working for them,
b) And worse – the high annual management charges would recur for as long as the investment continued to be held with that provider. Sapping away investment returns.
Did you know that if you save a lump sum for twenty years, the impact of paying an unnecessary extra annual fee would mean your final lump sum would be lower to the tune of 100% of your original investment?
That’s right, £1,000 returning 8% for twenty years would grow to approx £5k. Whereas £1,000 earning only 7% for twenty years would only grow to £4k. That’s a £1,000 difference!
What happened next
The FSA viewed this situation as an unacceptable conflict of interest. Because some providers offered much higher commission payments than others, meant that even IFAs had a skewed incentive to direct customers towards those options.
Of course, what enables providers to make higher commission payments? By charging high fees, of course. This meant that IFAs were incentivised to point consumers towards funds that charged high fees and redirected some of that to the IFA. It all looked fairly dodgy to say the least.
Whether this impacted the IFA as a major or minor factor is not the purpose of this article, many other factors will have guided the IFA when giving advice, and I am sure that some IFAs did try the best for their clients. But at the end of the day, because the customer wasn’t paying the IFA’s bills, they could not trust that they were receiving impartial advice.
In 2012 the FSA rolled out the ‘Retail Distribution Review’ regulations which banned the practise of providers passing commissions along to financial advisers. This meant that ‘fee-free’ advice disappeared over night. And advisers began agreeing fees and pricing upfront with customers before giving their recommendations.
So are financial advisers more expensive?
In theory – the cost of advice has never changed. Consumers were paying for advice back then, but just via indirect means.
But when comparing financial advisers fees pre 2012 versus now, it may ‘feel’ more expensive. This is only because we can now see the real cost of advice, whereas before, the true cost was hidden from the consumer.
One thing to console yourself with is this. ‘Trail Commissions’ was the name given to commission paid by the investment provider in perpetuity (funded by the annual management charge). This led to a situation where investors were still suffering extra fees 5 years after receiving the advice, to pay their adviser.
By bringing advice pricing into the open, the advice is now usually provided at a fixed cost for a one-off recommendation.
This means that you can be sure that you are paying a fair price for advice, and will not be subject to a bizarre situation where you continue to pay for that advice each year until you exit the investment. You want your investments to pay YOU dividends, not the other way around!
So in summary, the next time you ask for help for your summer budget, that financial advice might ‘look’ more expensive, but it probably isn’t. A counter-intuitive place to be, but ultimately a more transparent and open one.