THE Government has some critical issues to address in the coming months, but how clients choose to pay their advisers is not one of them.
A taboo topic in our society has always been disclosure of how much you get paid. It’s up there with sex, religion and politics in terms of impolite dinner conversation. But discussions about what you pay for your plumber, electrician and even the telephone plan you’re on don’t fall under this taboo and, it seems, neither do the commissions and fees advisers are paid.
It is accepted that, in a competitive market, value will rise to the top, much like cream, and that those enterprises which provide the best value will inevitably be the most successful. So let’s take a look at what you pay and how to determine value.
Is the nurse who takes care of you in hospital more valuable than the doctor who performs the surgery? Both are saving lives, yet their salaries are at polar opposites. Even plumbers nowadays charge a minimum ‘call out’ fee just to provide a quote — and then they want an agreement on payment before even picking up a wrench!
One of the hottest topics in our industry and receiving the most media attention at the moment is how customers should pay their financial advisers.
This doesn’t do it for me as dinner party conversation, but I’m prepared to discuss how I get paid. I have an agreement with my employer on how I get paid. I receive a base salary — provided I perform at a satisfactory level (if not, they dispense with my services). On top of that I may receive a bonus dependent on my individual performance and the performance of the company.
When times are good and when I perform well, I get paid more; when they are not so good, I receive less. That arrangement works for me. I have some certainty and it works for my employer in that they pay more for my services if they get more value.
Let’s look at the payment options for an adviser.
A flat fee is simple and straightforward and works best for transactions of a known size. It’s good for fitting a new car tyre, where the work involved is defined, not so good for an engine rebuild, where the scope of work involved is unknown at the outset. Surely the very premise of the full advice, know your customer model, is based on tailoring individual solutions for the individual needs of the client. A one-size-fits-all approach is not what good financial advice is about.
Importantly, a flat fee has no relationship to the results. It’s like buying a $49 mobile plan that gives $250 worth of phone calls — but to determine value, I need to know what is charged per minute of usage. It’s like buying $20 worth of petrol — it’s not quantifiable unless the litre cost is known.
A flat fee depends upon the work required being defined clearly upfront so the adviser and client know what the flat fee covers. In this way it is easy for a client to know what they’re paying for, so the fee paid is related to the specified output rather than the amount of work involved. Importantly, however, the output actually required, taking into account a client’s individual needs, does not rate in the equation. Nevertheless, the positives are that the client knows the cost, and it’s clear and simple to understand.
An hourly rate is generally the way lawyers traditionally charge, with time being billed in six-minute blocks. While it is simple, the fee paid bears no relation to the value of the work done, which can mean that the client gets great value or, alternatively, can lead to a high fee for time consuming work of little benefit. How many cases of insolvency have we seen where the majority of the assets seem to have been used to pay lawyers’ fees? Clearly, fees based on cost per unit of time are generally linked to the amount of work done, but in reality may not bear any relationship to the value of work delivered.
Trail commissions, costed per dollar of funds under management (FUM) on the other hand, give a clear link between the value of a client’s portfolio and fees paid. The adviser and client share in the upside of growth or the pain of a fall in the value of FUM.
One size does not fit all, and it’s clear that there are many options in the way fees can be charged by advisers, each of which have their own advantages and disadvantages. Different remuneration methods will suit different clients and need to take into account clients’ objectives and what is being delivered. Indeed, a combination of upfront fees on specific pieces of work and an annual fee for ongoing service is generally the norm.
The fees paid by a client for financial advice is clearly a topic for the adviser and the client to agree upon and determine value. The Government has many critical issues to address at the moment, ranging from climate change to the current financial situation. While it clearly has a vital role to play in providing transparent and well-regulated markets, it seems odd to add to the debate over how customers pay their advisers.
Surely it’s for agreement between the client and the adviser. In a competitive market, consumer choice will sort out those who fail to deliver value.
Tim Cobb is general manager, marketing and public relations, at Aviva.
