Commissions in financial services is often viewed as a dirty word. The word creates connotations of self-interested sales people flogging products to poor, unsuspecting clients – well, it does in my head.
I passionately believe that financial advisors should not accept any commission as a result of making an investment recommendation. But what about commissions on mortgages and insurance?
Two pre-conditions must be met for commissions to be okay
Mortgage advice (and broking) and insurance advice typically work best on a commission basis if two important factors exist:
- The advisor offers ‘whole of market advice’. That is, they deal with (compare) all, or the vast majority of providers in the marketplace. For example, we deal with every risk insurer in Australia and our panel of lenders/banks currently includes 43 lenders which probably represent over 98% of the mortgage market. If the advisor is offering whole of market advice then you can be confident that you aren’t missing out on a better deal.
- The price you pay is the same as if you went direct to the lender or insurance company. When it comes to insurance, you don’t pay a higher insurance premium if you go through an advisor [2]. In fact, the products that insurance companies sell direct to the public (often online) tend to be very poor quality and relatively quite expensive (because they are sold without advice). With respect to mortgages, there is no difference in rates and fees when going through a broker versus going direct with the lender. In fact, I know that we can often negotiate better discounts because of our experience, reputation, relationships and knowledge (of how banks work).
It’s a tax the banks pay because of the lack of competition
The banks pay mortgage brokers a commission in return for arranging a new mortgage. The advantage (to a bank) of using mortgage brokers is that it’s a variable cost. Unlike running a branch network, which is a very expensive fixed cost, they only need to pay a mortgage broker if they get a new customer. Therefore, the banks need less branches and staff if they use mortgage brokers.
The Big 4 banks have more than 80% market share of the mortgage market. I believe that mortgage brokers dramatically improve competition and, to some degree, keep the big banks honest. The big bank’s past behaviour suggest that they are only interested in maximising short-term [1] profits for shareholders. I view the commissions they pay mortgage brokers as a tax to create more competition.
Commission-free insurance advice doesn’t work in our experience
One of the common complaints or concerns with commission-based insurance advisors is that they have an incentive to recommend more cover than you might actually need (in order to maximise their commissions). I agree that this conflict of interest exists.
However, charging a fee (instead of taking a commission) for insurance advice does not work for three main reasons in our experience:
1. Changes in circumstances and/or new products
We used to offer insurance advice on a fee-for-service basis until we worked out its not in the clients’ best interest. I recall we prepared some insurance advice for a client and charged them a fee. Their situation was rather complex. We implemented the advice. Then, approximately 6 months later, their financial situation changed significantly. The insurance advice we prepared was now out-of-date and worthless. An advisor that accepts a commission actually helps spread the cost of providing the advice over the long term.
2. Helping you with a claim
If you ever need to claim on your insurance policy it is best to have an advisor manage it on your behalf. Not only will this save you a lot of time but also, we know what we are doing (more experience) and can represent your best interest. If you deal with a fee only advisor, you might end up receiving a large invoice for such a service. Commission-based insurance advisors do not usually charge for managing claims (we certainly don’t).
3. Clients with basic insurance needs
We have some clients with very basic insurance needs. They need some advice but it’s not worth them spending a lot of money on advice. In this regard, a commission is the cheapest option.
I believe that commissions associated with insurance advice is acceptable as long as you are comfortable that your advisor is ethical and professional i.e. they are not going to recommend more cover than what you really need.
Commissions must not exist in financial planning… ever!
When it comes to financial advice, the above two preconditions never exist. That is, not all investment products/assets pay an advisor a commission. In fact, the best products/assets rarely pay a commission. The ones that do pay commissions are almost always not investment-worthy (i.e. poor quality). Secondly, the existence of the commission almost always increases the cost of the product.
It is for this reason that I strongly advise that you only take advice from someone that is independent, that sits on your side of the table, that doesn’t have a vested interest in the advice outcome. In short, a fixed fee-for-service (not percentage) is the only fee structure to agree to.
Financial advice on an hourly rate and/or piecemeal advice
There are a number of reasons why we do not offer financial advisory services on an hourly rate or piecemeal basis:
1. We want you to contact us
We never want a client to be reluctant to run something past us. An hourly rate arrangement can create situations where clients are reluctant to communicate with us because they are concerned about getting a bill and wonder whether it’s “worth” discussing the issue with us. Fee arrangements should never get in the way of being able to help our clients.
2. We need to spend as much time developing advice as we feel is appropriate
Sometimes when formulating advice we need to consider various options. Whilst we might end up discounting said options, it’s still important that we thoroughly investigate them. It’s often impossible for clients to understand and appreciate the amount of time involved undertaking this work. Also, we don’t want to be in a position where we have to waste time recording and communicating the work we have done and having to justify why it was necessary.
3. We spend time looking for opportunities for you
We spend time on training and education, researching markets and products, reviewing potential investments and so forth. The fees that we receive from clients allows us to undertake these activities for their ultimate benefit.
4. We need to be fairly rewarded for the work we do
An hourly rate rarely represents a fair exchange of value. There have been several times when I have spoken to a client for a short time discouraging them from making a particular investment, suggested an alternative investment, identified a better structure, highlighting a potential tax problem and the list goes on. Such conversations can add tremendous value – sometimes saving or making tens to hundreds of thousands of dollars! A monthly retainer fee better reflects the value created by having a long-term relationship with an independent planner that knows you.
Our goal is to build a long-term relationship with clients that value dealing with an independent advisor. We charge a fixed monthly retainer fee. This allows the client and us to put the cost of the advice aside and focus on what truly matters. That is, helping them achieve their financial and lifestyle goals.
Would you like to learn more?
I hope this blog gives you a better understanding of how we work and why. If you have any questions, do not hesitate to reach out to us.
[1] I say short term because I believe that if the banks looked after their customers (i.e. focused on satisfying their needs with less focus on initial profit) that this approach would actually result in creating significantly more value (and profit) in the long run. But executives worrying about their tenors, the desire to achieve short term bonuses and stock analysts don’t reward (they actually punish) such behavior.
[2] Some independent advisors do offer commission-free insurance advice where they rebate their commissions and/or discount the premium. We have done this in the past believing it was in the clients’ best interest. Our experience has shown us otherwise. In fact, only a few clients (ones that have a very large amount of cover) are likely to benefit from such arrangements. See my comments under “Commission-free insurance advice doesn’t work in our experience” for the problems we experienced.
