One shocking sentence sums up why you should manage your own money
Merryn Somerset Webb Oct 05, 2012
Every now and then one stumbles across a little detail or throw away comment that makes everything utterly clear in one’s mind.
That happened to me this week. The comment in question came under an article on Moneymarketing.co.uk (Money Marketing is a trade magazine for financial advisers).
It was just a short line in a longer comment. But it summed up exactly what’s wrong with the financial advice industry – and why it’s absolutely vital that you take more control of your own finances if you want to avoid being ripped off.
Commission corrupts – even financial advisers admit it
At the moment, most financial advice looks to its recipients as if it is more or less free, because they pay nothing up front.
They are generally close to clueless about the fact that their independent financial adviser (IFA) takes a chunk out of their money before he passes it on to a product provider (such as a fund manager or insurance company).
And many don’t understand that he usually takes another bite of the cherry every year in the form of what the industry calls 'trail commission'. This is a fee he gets from the product provider for every year that you continue to hold their product.
Confused? Well, imagine how it would be if you paid your estate agent in the same way. You would be paying him his two percent up front when you bought a house through him.
But you’d also pay him another 0.5% of the value of your house for every year you continued to live in it. (Regardless of whether you ever had the good fortune to see him again or not).
I might be boring you by now – which is how the industry gets away with all these outrages. But bear with me. We are getting to the interesting bit.
The Money Marketing article was about the Retail Distribution Review (RDR). Under RDR, from 2013, IFAs will have to charge clients an upfront fee for advice, and commission will be banned.
The comment came from an adviser who has already made the shift. He used to get paid via various commissions and now charges transparent fees instead.
Here’s what he said: “Interestingly (and I'm not especially proud of this) since moving to a fee-based model I notice that my advice has changed somewhat in the clients’ interest.”
There you have it. A clear admission that the existence of commission corrupted him. That – while being labelled as independent – he recommended products to his clients on the basis of the commission kickbacks he would get from providers, rather than on the basis of what might work out for said clients over the long term.
This matters. It isn’t surprising – we all know what human nature is – but it should come as a handy reminder of just how rarely the financial industry covers itself in glory.
It’s also worth keeping an eye on what the financial industry is trying to get you to invest in now. According to FT Adviser, there has been an “increase in advised sales of retail investment products that pay recurring trail commission ahead of the RDR.”
Why? Because if you flog a product before the new rules come in in 2013 you will get to keep receiving trail commission indefinitely. If you do so after they come in, you won’t get any at all - what with it now being considered deeply immoral and all that.
I wonder if the advisers upping their sales of commission-carrying products now feel that the system is biased in their clients’ interests. Or not.
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How to take investing into your own hands
All this might be making you feel nervous. However there is, as ever, good news lurking behind the bad. We are constantly told by the financial industry that advice is a must – that we all have unique requirements that mean we need unique advice.
We are also being told very firmly by some advisers (the ones that aren’t really getting it) that abolishing commission means the less well off will no longer get financial advice.
The argument goes roughly like this: “If we have to tell people how much we charge them they will be horrified, and not want to pay us to get advice. Therefore, for we must continue to hide our charges and rip them off. We do this for their own good.”
Nonsense. Anyone with enough money to require financial advice (rather than debt advice or a nod in the direction of a good savings account) can afford to pay a fee, should they feel it offers value.
But mostly we all have much the same financial needs. If we do have a very specific need – some kind of specialist insurance, or an annuity perhaps – we can go to an adviser for what SCM Private’s Alan Miller would call one off “tactical advice” rather than general strategic advice. (You can read my interview with Miller and his wife Gina here, and if you're not already a subscriber, get your first three copies free.)
But for general investing – ISAs, pensions, straight-forward insurances and so on - generic advice from trusted sources all over the internet, combined with an account at a good investing platform such as Hargreaves Lansdown should suffice. You can listen to me talking about this more on the BBC's Moneybox (from last week).
If you are getting started in investing you should sign up for our free MoneyWeek Basics email. You might also want to watch some of our video tutorials.
And take a look at the core portfolio of investment trusts we suggested here a few months ago.
I’ll be updating these in the magazine in another three months. One I am keeping my eye on as a possible addition is the British Empire Securities and General Trust. It is a new favourite of the managers at Troy Asset Management. (See next week’s magazine for an interview with Troy’s Sebastian Lyon).
It invests in companies trading on a material discount to the manager’s estimate of their net asset value (NAV). Half of its assets are in Europe – which we currently like, because it’s cheap. The trust also trades at an 11% discount to its own NAV. That, says Troy, means you are effectively getting a “discount on a discount,” which surely can’t be a bad thing.
British Empire is also highly unlikely to be recommended to you by a financial adviser this year. Why? Investment trusts don’t come with commission.
• This article is taken from the free investment email Money Morning.
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