This article is taken from Merryn Somerset Webb’s free weekly personal finance email, MoneySense. Click here to sign up now: MoneySense
I wrote an article in the Sunday Times a few weeks ago which has caused quite a fuss. It was about how to find an Independent Financial Adviser (IFA). My argument was simple. The majority of IFAs are paid on commission by the providers of financial products and I can’t see how that is a system that can be anything but corrupting. There are lots of really good IFAs out there (and I’ve heard from lots of them this week!) but they are working with a system that does them no favours at all.
Imagine you bought a new-build buy-to-let flat and the agent who sold it to you not only took the traditional 2% upfront commission on the sale, but also insisted on charging 1% of the rental income paid by your tenants every year for as long as you owned it. Furthermore, what if you then found out that the 2% upfront commission and the 1% annual levy had not been set by the agent, but by the developer of the flat? And that elsewhere in the area there were identical flats for sale from another developer that would have cost you only an upfront 1% but your agent hadn’t shown them to you.
You’d be horrified, wouldn’t you? But that’s the kind of thing that happens a great deal of the time someone in the UK buys an investment fund or a ‘product’ via a financial adviser. If you buy, say, an investment fund from an adviser, you pay an upfront commission of a percentage of the money you are investing and then a commission for every year that you continue to hold the investment they suggested you buy (this is called trail commission).
What this system means is that many of us never meet a real financial adviser: we meet commission-hungry salesmen masquerading as advisers. Even when advisers have no formal link to product providers, thanks to the commission system they can be tempted to suggest investments based not on their suitability for you but on the levels of commission they will receive.
They can also find themselves utterly unable to stop suggesting that you buy and sell things when you might be better off doing nothing at all. Note that if they look at your portfolio and say it looks just fine they get nothing. If they look at it and say you should sell everything and buy some new unit trusts they could make themselves 5% of the value of your investments. That doesn’t make it easy to send people away with instructions to stop worrying and do nothing.
The upshot is that the only way you can be absolutely sure you will get unbiased financial advice is to reject commission and insist on paying for advice as you get it. This is what we do when we consult other professionals. Do you pay your solicitor an upfront percentage of the value of your will when they write it for you? Of course not. You just pay them a flat fee for their time.
MoneyWeek now has a database of IFAs who charge on a fee-only basis. Click here to find an IFA in your area: Directory of fee-based IFAs
As far as I can see it should be exactly the same with IFAs. They’ve taken lots of exams to get qualified and they should be seen as respectable professionals and paid accordingly. There are many good and some excellent IFAs out there and I can’t see why they should see anything else as reasonable.
Unfortunately not everyone agrees with me. Well, when I say not everyone, I mean not everyone who is an IFA. The response to my Sunday Times column (which you can read in full here: Take my advice – give advisers a wide berth has so far been brutal. I’ve had a lot of personal emails and letters but my views have also been the subject of much discussion (much of it not very nice) on Citywire. You can look at the whole lot here.
It is fascinating stuff – when people get this angry and this personal you can usually be sure they know they’re standing on slightly shakey ground – but the really striking thing about it is that not one person actually makes a real argument in favour of the commission system most of them use.
On the face of it the best one is that the commission system means that the poor – who can’t afford fees – have access to the same advice as the well off. As the cost of the advice they get is paid out of the money they invest every month they never have to come up with a lump sum. But while this sounds reasonable it doesn’t actually make any sense to me at all. If you can’t afford to pay for advice you may well not need it – if you have debts or if you have no savings, aren’t you better off paying off the debt and building up a cash pot for emergencies before you do anything else?
And wouldn’t any good IFA who came across someone with no money at all direct them to the highest interest paying account out there, tell them to get saving and to come back when they have six months’ worth of living cash in the bank?
Anyway, if IFAs are so keen on helping the poor and so convinced that investing should come before saving for them, or that they should buy their insurances via IFAs rather than via a cheap online broker, why not allow them to pay fees in monthly installments for a year rather than commissions every month they hold the investment? That would help everyone…wouldn’t it?
If you are looking for a cheap online broker, by the way, you might visit www.moneysavingexpert.com where Martin Lewis suggests getting life insurance at cavendishonline.co.uk, for example – the site allows you to chose to pay a fee of £35 instead of commission.
Finally, it’s worth noting that even if one accepted that paying commission is good for the poor, the poor quite clearly haven’t: all studies show that the client bases of IFAs come almost entirely from the wealthier end of society.
All advisers now have to offer you the choice of paying by commission or paying a fee but I think most of us are best off using advisers that only charge fees, not least because the more of us that choose this option the more IFAs will be tempted to make the shift out of the commission system.
At the moment fee only IFAs aren’t that easy to find . Www.unbiased.co.uk lists thousands of IFAs and allows you to choose how you want to pay (fees or commission) but even if you tick the fees box you can’t be sure that the adviser you end up with charges fees only – many list themselves as doing both so you do need to double check when you ring.