Is the financial services industry broken? Or is it our attitude to money and advice? Or both?

My passion for the financial services industry started very early in my career while auditing some large credit unions as a graduate accountant. When I moved to work for two of the big 4 Chartered Accounting firms (not at the same time of course) I ensured that I was working on as many financial services clients as possible. I recall thinking back in the late 1990’s how much I thought people would value independent financial advice. “People just need to be able to trust and rely on the advice they are being given and be certain that no conflicts exist. There’s huge value in that” I thought.

In 2002, I decided to do something about it. Initially it was the lack of advice and service in the mortgage broking industry that attracted me to launch ProSolution. I believed that ’real advice‘ was the missing piece-at that time brokers tended to focus only on selling a product. Then, in 2007, I was attracted into the financial planning industry mainly for 2 reasons. Firstly, I saw my clients make lots of mistakes that I wanted to help prevent (if I had a financial planning licence I could legally provide that advice and hopefully stop them making mistakes). Secondly, no financial planner could consider property on an equal footing. It’s not that I believe everyone should invest in property – not at all. It’s simply a matter of someone being able to go to a trusted source that knows equal amounts about property and shares to receive educated and unbiased advice. Most people believe if they go and speak to a financial planner that they’ll only talk about managed funds or shares, not property (which is true 99% of the time).

This all sounds great on paper but in fact I suspect/believe the reverse is true. Before I get into that, let me lift the lid on this industry.

It’s not about the client

Lots of people complain how difficult it is to find a trustworthy mechanic. The problem is that if you aren’t mechanically minded, mechanics could tell you almost anything and convince you to spend X or Y on your car and you have little way of ascertaining if you’re being ripped off.

Sadly, the financial services industry is the same, to a great extent. I believe that too many businesses prey on the lack of financial knowledge that many people suffer. The big end of town is by far the worse culprit. They design overly complex products (to baffle investors), play on two major core emotions (fear and greed), try and hide the fees in products, promise quick gains or easy money and so forth. It’s really a “dog eat dog” world out there. Buyer beware!

Businesses are bought and sold and services are provided under the table on the basis that a certain amount of a particular provider’s product is sold to their client base – so the conflict isn’t always visible unless you know what’s going on behind the scenes.

So you’ve lost confidence? You should have!

With the advent of the Internet and the greater access to information that comes with it, people are savvier to what’s been going on. The GFC has helped too because people have lost money despite “professional management” and the previous claims these managers have made. If everyone makes money in the market when times are good, and everyone loses when times are bad, what’s the point of paying someone to manage your money? Of course, this is a generalisation and it comes down to the manager and the methodology – for example, I’d be very happy giving my money to Warren Buffett to invest.

The financial planning industry hasn’t really helped itself in my opinion. They have been slow to react to the groundswell of distrust voiced by the Australian public and the government has had to move to ban commissions to encourage greater transparency on fees.

The damage is done and it will take years to repair the public’s trust in financial advisors. Only about 15% to 20% of Australians receive financial advice from a financial planner which is a huge indictment on the industry.

Stupid you

So banning commissions is the solution? Right? Wrong. Very wrong!

The problem with good, honest financial advice is that its value often isn’t always obvious or evident (or measurable) when the advice is given. It could be not until years later when you can reflect back on advice you were given and recognise/appreciate its value. It’s like when you purchase an investment property – you don’t really know how it’s going to turn out but years later you can clearly measure the capital growth. So as a buyer of financial advice, what do you do? How can you pay for something if you can’t measure its value? The typical response is to simply reduce your risk by paying less. An ASIC survey a few years ago suggested that most people expected to pay $300 on average for financial advice – $300 won’t even cover the compliance work that a financial planner has to do.

The benefit of commission is that it spreads the cost of the advice over a few years. Therefore, over a 5 to 10 year period, the commissions add up and are sufficient enough to attract smart professional advisors willing to invest the time to help clients. In a commission free world, you have to charge for the time you expend upfront and there’s a lot of work (hours) to develop a tailored investment strategy for a client. Therefore, this increases the cost of getting financial advice (compared to a commission based advisor) and increases the risk for the client – because again it’s difficult to measure if you’re getting value for money.

To add to this, a fee for advice style relationship means that an advisor has to send you a bill each month, quarter or whenever you speak to them. This forces the client to reconcile value each time they pay a bill. Again, because value can be longer term, it tends to play on people’s mind and the “easy” response is to simply stop paying.

These comments above are generalisations. Of course, there’s a group of people that appreciate and recognise the value an independent financial advisor can provide and are happy to pay a fair price for their services. However, in my opinion and experience, they’re a minority. The majority of Australians don’t fit into this category and for that reason, paying a fee for advice probably won’t feel like a natural solution. This means less people will seek advice and that’s a bad thing.

But what about property and other quality investments?

The biggest problem with commissions is the conflict. Property doesn’t pay commissions so a commission based advisor is not incentivized to recommend property. Also, some high quality investments don’t pay commissions (and some won’t even deal with commission based advisors). This is the major drawback of dealing with commission-based advisors. I agree that this is not workable because it does greatly compromise the quality of advice. So commissions in their current form must absolutely go – no arguments from me.

The end result is no one wins

So what is the solution? Frankly, after a decade of advising clients and operating a financial services business, I have no idea. Our financial planning business is nearly 5 years old and it breaks even at best. I’m really starting to think that quality, unbiased (no bias between property and shares) advice and a profitable business are mutually exclusive. I only continue because I deeply believe we’re doing the right thing.

If clients insist on paying a very small amount for financial advice, they’ll get very poor advice – if any at all – and no value. Financial planning businesses will continue to target high net worth clients with large incomes because they are the only ones willing and able to pay for good advice. Middle and lower end Australia (arguably the ones that need advice the most) will miss out!

What are others doing?

At the end of the day, businesses need to make money to be sustainable – no point developing a relationship with a business if they end up closing their doors in a few years because they aren’t sustainable. So what I have witnessed occurring is that financial service firms look for other ways to make money. For example, a common emerging trend is selling property to clients. Property developers approach accountants, financial planners and mortgage brokers and offer large commissions (2% to 5% of the property’s price – so $10,000 to $25,000 of income per property!) to recommend property to their clients. Some businesses are making lots of money doing this (i.e. the developer and advisor are making money, not the client) but arguably puts the clients interest last (assuming you believe that off-the-plan style property doesn’t make a good, long term investment… they don’t!).

Commissions can work

It’s interesting to point out that I believe that commissions do work in the mortgage broking industry. The benefits that mortgage brokers provide are typically in the form of better service (a personal and professional relationship) and more of an advisory role (rather than product sales). Most mortgage brokers have a large panel of lenders that represent 98% of the mortgage market (by market share). There are small differences in commission between lenders but most mortgage brokers are focused on the ‘client for life’ philosophy so any differences are just ‘swings and roundabouts’ – retaining a client for the longer term is where the value is.  The cost of a mortgage (to the borrower) is the same regardless if they went direct to the bank or via a mortgage broker. I honestly believe that people are better off using a mortgage broker and that commissions don’t intrude on that value proposition.

Change your perspective or suffer the consequences

The new financial services laws around banning commissions and so forth are designed to protect the public from a minority of advisors that don’t put their clients’ best interest first (the bad apples). Unfortunately, while the laws are probably necessary, they do have negative impacts on the whole industry. For example, a perfectly honest advisor has to deal with all the business and compliance work just because of a few bad apples (which forces the cost of delivering advice up). The state of the laws and the resultant economics of running a financial advisory business aren’t going to change – ‘fee for advice’ advisors will have to charge a fair fee for their service (or compromise on the quality of advice through less tailored advice). At the same time, there will always be product sellers disguising their wares as ‘advice’ and making it easy to buy.

The way I see it is that it’s the public that will need to get their head around reconciling the value of good, honest advice. I think part of it is a cultural issue – for example, as I understand it, in the USA most people wouldn’t make investing decisions without advice. It’s not a question of whether to use and advisor. It’s more a question of which advisor to use. So I believe it will take a combination of industry reform (no commissions) and a change in attitude towards valuing good advice to create any meaningful improvement. Industry reform alone will likely just make things worse.

So why am I writing about this topic and being so open and forthright? Firstly, it’s a very important issue because it impacts on our nation’s wealth, prosperity, productivity and future. A nation that harnesses its wealth is vastly different to that which doesn’t make the most of its financial opportunities. Secondly, as a client of our firm, I believe it’s important that you understand our mission, our values, what we stand for and that we’re prepared to swim against a very strong tide to do work that we’re proud of and ultimately change our clients lives for the better. It’s important to me and I believe it should be important to you too.

I would love to hear your comments – what do you think?