News that the Financial Services Authority (FSA) wants to ban independent financial advisers (IFAs) from charging comission should be met with whoops of joy by private investors.
For now, an estimated 80% of advisers’ payments come from commission, received from financial firms when they get their clients to invest in them. Critics have long argued that this leads to “commission bias” – whereby ‘independent’ advisers are tempted to recommend the products that pay them the biggest commission, not the ones that are most suitable.
Andrew Fisher, chief executive of fee-only IFA Towry Law, puts it bluntly. “This is a great day for the consumer. It is a ban on the bribery and corruption that has plagued the industry. Mis-selling driven by commission should now end.”
So what are the new rules?
Under the new rules, which the FSA plans to implement from December 2012, IFAs will have to agree a cost up front, then give their clients the choice of paying it as a fee or to have the amount deducted from their premiums.
Advisers will also have to be better qualified, and will be split into those offering “independent financial advice” or “restricted advice”. Those offering the latter are advisers whose recommendations are based on a limited range of products, such as the sales staff in bank branches.
The only downside to the FSA’s plans is that all this won’t happen until 2012. But don’t despair. You can still get impartial advice now, and there’s plenty that you can do by yourself to keep the charges you pay on your investments to a minimum.
How to get independent financial advice
Before you start worrying about finding a financial adviser, ask yourself if you really need one. One major complaint seized upon by various vested interests has been the notion that upfront fees mean that lots of people won’t be able to afford financial advice anymore. But this is nonsense – people have always paid for their financial advice – this is just a way of making it more transparent.
And, as a rule of thumb, if you can’t afford to spend a few hundred pounds on advice then your financial situation probably isn’t complicated enough to need a professional adviser. But if you feel you do need the help of an IFA, then you can already find an increasing number who charge on a fee-only basis. These IFAs will charge you an upfront fee for their advice, and either won’t accept commission, or will offset any commission received against your fees. You can find a list of fee-based financial advisers here.
How to cut the cost of investing
The other good thing about banning commission is that it could mean that financial product providers will have to compete harder on charges. If IFAs feel free to recommend any product they like, without the temptation of commissions to cloud their judgement, then sales of expensive products such as unit trusts are bound to come under pressure from cheap competitors such as exchange-traded funds (more on these below).
In the meantime, there’s plenty you can do to cut the cost of investing yourself. And it’s important that you do so – charges make a big difference to your portfolio. For example if you invest £10,000 in a fund that grows at 7% a year, then in five years you’ll have a pot worth £14,000 – if you don’t pay any charges. But even a charge of just 1% a year will cut your nest egg down to just £13,338. A 2% charge reduces it to £12,667. Extend the return period to ten years and with no charges you’d have £19,670, but with 2% you’re left with just £16,070.
If you are buying a unit trust then there are a number of ways to cut charges. Firstly there’s the initial set-up fee. This can be as high as 5%, but can usually be avoided or at least reduced by buying your fund from a fund supermarket. These supermarkets can sell funds without the initial charge due to their mass buying power. Hargreaves Lansdown and Fidelity offer funds supermarkets.
But why go for an actively-managed fund at all? These tend to have higher annual management fees – up to 1.5% a year – because there’s an expensive fund manager to pay for. But “three-quarters of these managers actually underperform the stock market, sometimes by a long way, and for that they want to take more of your money,” as David Kuo of Fool.co.uk says in The Independent.
In most cases, in other words, you would be better off simply sticking with an index tracker fund. These funds (which simply aim to track a stock market index, as the name suggests) have annual running fees of as little as 0.3%. Exchange traded funds (ETFs), are stockmarket-listed instruments which do pretty much the same thing, and offer an even wider variety of markets to track.
So while the FSA’s reform plans are great news and will help simplify getting financial advice it is still possible to get independent financial advise that is simply priced and unbiased from fee-based advisers. And with a little savvy shopping you can buy financial products cheaply yourself.
• This article is taken from our weekly MoneyWeek Saver email.
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