It’s a year since ‘depolarisation’ was meant to give clarity to the market in independent financial advice, but most of us are still confused about what IFAs do. Simon Wilson explains:
What on earth is ‘depolarisation’?
It’s financial-industry jargon for the freeing up of the financial advice market on 1 June 2005. From 1988 until last year, financial advisers were ‘polarised’ into one of two types. Either they were fully independent (an ‘IFA’) – able to scour the whole market for the products best suited to individual customers – or they were ‘tied’ to one provider and could only sell that provider’s products.
Under the new system, both types still exist, but there is also a third option, the ‘multi-tie’, which means an adviser who can sell from a range of selected providers. The ‘multi-tie’ option was created by the Financial Services Authority after pressure from high-street banks, who wanted to get in on the burgeoning market in financial advice. Under the new system, they can earn commission by recommending and selling the products of other providers. From the consumer’s point of view, the ‘multi-tie’ option was supposed to bring greater transparency and choice.
Has it worked?
Not according to research published last week by IFA Promotion, a trade body representing around 90% of IFAs and sponsored by 31 financial groups, including big insurers such as Legal & General and Norwich Union. Their survey found that eight in ten adults don’t understand the difference between the various types of financial adviser. It also reported that 70% of the 6.6 million people who received financial advice over the past 12 months believe they spoke to an ‘independent financial adviser’ (IFA) – a highly unlikely prospect, given that true IFAs account for only a tiny proportion of all advisers.
Some analysts fear the ‘multi-tie’ system will worsen the potential for conflicts of interest in the industry. In recent years, many product providers – concerned that power in financial services is moving down the chain to distributors – have acquired shareholdings in groups of (commission-charging) independent advisers, and yet these same companies’ products appear on the advisers’ lists of recommended investments.
So how do I know an adviser is independent?
A genuinely independent adviser has access to the whole of the market, not just a section of it. But that’s not the only criterion. To qualify for the title of IFA, advisers must (by law) offer customers the option of payment by fixed fees, usually calculated on an hourly rate, rather than by commission on investments. This provision is designed to cut out the risk of ‘commission-bias’ on the part of advisers in favour of more providers who’ll cut them a bigger slice of the pie. This differentiates IFAs from another new kind of adviser, who also has access to the whole market of financial services (from estate planning to investment management; pensions to life insurance), but who charges only commission, not fees. This kind of adviser is known as a ‘whole-of-market’ adviser, but is not, strictly speaking, an IFA.
If you aren’t sure what kind of adviser you’re dealing with, ask them. IFAs are obliged by law to give you this information when you first come into contact with them, in the form of an ‘about our services’ factsheet. They are also obliged to provide a detailed ‘menu’ of charges comparing their rates of commission with the industry average.
What’s best – commission or fees?
The advantages of paying an agreed fee (of around £75-£250 an hour, plus VAT) are that you know exactly what you have to pay, and that you know your IFA was under no pressure to sell you something in order to make a living. It might also be possible to agree a limit or a fixed price beforehand. The flip side is that you will still be charged even if you decide not to buy anything. Paying by commission can seem cheaper, or indeed free, because the adviser gets his commission on the sale from the provider. But in truth, you are still paying for the advice because part of your investment will go towards paying that commission. Depending on the type of financial product involved and your individual circumstances, it can work out much cheaper to pay a one-off fee upfront, rather than commission over many years. What’s more, there’s always a potential risk involved in commission-based transactions, since the IFA needs you to buy the product in order to make any money out of you.
Do many people choose to pay by fees?
According to the Association of IFAs, the number of customers opting to pay fees is slowly rising, although it still only accounts for a small proportion (around a fifth) of overall business. While some IFAs keep quiet about the fee option, others have embraced the fixed-fee route as a crucial part of the drive to make financial advisers into a recognised profession on a par with accountants or solicitors.
How do I find a good IFA?
Personal recommendation is the best place to start. Among the alphabet soup of qualifications that advisers can take, the minimum you should be looking for is the Certificate in Financial Planning, while a Chartered Financial Planner signifies an IFA with considerable expertise and experience. For a good overview of what to expect from an IFA, as well as a searchable database of advisers, see the Personal Finance Society’s website at www.thepfs.org. Alternatively, for a list of IFAs in your area, see IFA Promotion’s excellent website at www.unbiased.co.uk, or ring 0800-0853251. For extra peace of mind, there is also an official register of advisers on the FSA’s website at www.fsa.gov.uk.