If you need financial advice, how much should you expect to pay for it? Of course, the cost is what you pay, but value is what you receive. The value needs to exceed the cost for it to be worthwhile. So, how do you assess the value of financial advice?
Whilst the answers to these questions can vary significantly, we must take into account that value assessments can be subjective, and I wanted to share my insights to help people with this analysis.
Financial advice fees create tension
On one hand, the lower the financial advisory fee you pay, the more money you save to invest and that has to translate to a higher likelihood of achieving your financial goals.
On the other hand, in many respects, you get what you pay for. The cheapest financial advice is not always the best.
Your willingness to pay more for financial advice may create some valuable consequences:
- It is likely that you will attract an advisor with more experience. An advisor with 20 years of experience isn’t going to work for $20 per hour – a graduate with zero experience might;
- It will allow that person to spend more time thinking about (analysing) the advice they give you. However, if profit margins are very thin, it inevitably creates pressure to cut corners – and certainly no scope to provide proactive advice; and
- The more human and economic resources a firm has, the more it can invest in their people and systems to continually improve the value they provide you. Better research, more analysis and more thinking time creates value in the long run.
The truth is, because of the tension advisory fees create, a balance must be found. The fees you pay must be as low as possible. But not too low that it risks the value of the advice you receive.
How much does it cost to give financial advice?
The cost of giving financial advice can typically be categorised into four components.
The cost of employing the right people can be significant. The quality of the people determines the quality of advice and service that you can expect to receive.
Of course, the knowledge and experience of the advisor is paramount. Someone with very vast knowledge and many decades of experience will usually command a higher salary.
For example, I’ve spent years honing my craft, learning, investing in myself. Consequently, the advice I give is substantially more valuable than an advisor with only a couple of years of experience. But it comes at a cost.
(2) Compliance and risk
There are a number of costs associated with having your own financial services license (AFSL). These include paying for an audit at least annually, training and education, license related fees paid to ASIC, professional indemnity insurance – the cost of which rivals some of the riskiest medical occupations and the time cost of fulfilling all compliance obligations.
Giving advice does not come without risk. Advisors accept a huge responsibility for formulating the right advice. Advice on simple matters is of course a lot less risky. However, advice that involves large sums of money or complexity carry higher levels of advice risk, because even small errors or misjudgements can have significant financial consequences (in dollar terms). Higher risk engagements attract higher levels of advisor compensation (fees).
All businesses have overheads including office occupancy, technology and software costs and so on.
A sustainable business must make a profit. The profit must be sufficient enough to compensate the owners for the business risks and provide a return on the capital contributed towards the business including any sweat equity. You don’t necessarily want the firm to be making huge profits, but they must have a sustainable business.
Average cost of advice
Last month industry consultants estimated that advisers need to charge an average fee of at least $3,500 per client. The cost to deliver a Statement of Advice is estimated to be $6,500, on average. The main theme is that the cost to operate a financial advisory business has increased substantially over recent years.
I estimate the cost of compliance, risk and overheads to be over $2,000 per year per client. That’s a basic cost that needs to be covered before we even do one minute of work.
Most advisors charge annual fees in the range of $3,000 and $20,000. Some advisor fees are based on a percentage of your assets, which you should avoid, as it is rarely a fair representation of the work involved.
There needs to be enough scope for an advisor to add value in excess of fees
The more complexity you have and/or the more money you have to invest, the more scope there is for an advisor to add value. If you have a large investment balance, a small improvement in investment performance can have a significant impact in dollar-value terms. Hence the cost of advice is easily offset by the value of the advice.
However, if there is little scope to add value or you have little to invest, offsetting the cost of the advice (with value received) will be challenging.
For example, I estimate it would cost me at least $3,000 per year to look after a client with a share portfolio of $200,000. That fee only covers my costs. That fee equates to 1.5% p.a. of the portfolio’s value. Therefore, for the client to be better off, I would have to generate an additional investment return of more than 1.5% p.a. than say what a diversified index fund could provide. Of course, this is possible, but why take the risk. As such, I would never agree to take on this client. Fees are certain, returns are not.
Of course, if this prospective client had other needs that I could help with, the value of that would need to be taken into account.
How do you value advice?
Clearly the value that financial advice produces must significantly exceed its cost. Most prospective clients find this value assessment a difficult and subjective assessment to make. For example, sometimes perfectly sound financial advice doesn’t improve your net worth until some years later. Does that mean it is worthless? Of course not.
I have identified four sources of value.
Formulating a long-term plan
Few people have the requisite knowledge and experience to develop a holistic, long term financial strategy. A strategy must consider many factors including cash flow, risk, asset allocation, level of borrowings including how to repay them, how superannuation integrates, tax, estate planning and risk management. Having a clear and simple-to-understand strategy outlining what you need to do over the coming years to achieve a comfortable retirement is very valuable. Whereas, implementing the wrong strategy can cost a lot of money and waste a lot of time.
Correctly implementing the plan
A financial plan is worthless unless it is implemented correctly. This includes knowing which methodologies to use and when, when to invest more or not at all, what tactical changes to make, which advisors to trust (e.g. buyers’ agents) and so on. I’ve seen people destroy a lot of value through incorrectly implementing an otherwise perfect strategy. Avoiding making just one insidious mistake could save you literally several tens of thousands of dollars. A small 0.5% p.a. higher return on $500,000 will generate nearly $50,000 in additional value after 10 years (and $190,000 over 20 years). Even small, incremental improvements in returns can create substantial value.
Navigating inevitable changes and opportunities
No one needs reminding this year how unpredictable life and markets can be. It is valuable to be able to lean on a trusted advisor that understands your circumstances and your goals, to counsel you through turbulent times, difficult decisions and the like. In my experience, it can be difficult for clients to make decision when they are under emotional and/or financial pressure.
Apart from things like pandemics, there are lots of things that can change over time including your personal circumstances, your goals, financial markets, new investment opportunities, tax and super rules and so on. Each change can create risks and opportunities.
Higher confidence, less stress, freedom and happiness
Often my clients say that they enjoy sharing the responsibility for making financial decisions for their family. That is, this responsibility no longer solely rest on their shoulders, which can be a burdensome obligation. Making financial decisions is also not their core skill, which adds to stress levels. Whereas I am almost always thinking about investing, as it’s something I’m deeply passionate about, unlike most (all) of my clients. It is also my job to take responsibility.
Why most advisors prefer to not offer once-off advice
Sometimes clients request us to provide once-off, piecemeal advice on a specific financial planning matter. We rarely do this work, particularly if they are not an existing client.
Providing once-off advice is often unrewarding, both professionally and commercially. There’s a substantial amount of emotional labour involved in building a trusted relationship with a client. Getting to know them, their goals, risk profile and so on. To do all this work, as well as fulfil all the compliance obligations, without any expectation of being around in the future to see how the advice turns out is unrewarding.
The best thing about working with clients on an ongoing basis is that you both invest in nurturing a relationship based on mutual trust. You have a shared goal. You share the successes along the way and, from an advisor’s perspective (at least mine), this gives me confirmation that the advice I give creates positive financial and lifestyle outcomes. I am proud of the work I do.
This rarely exist with once-off advice, as there’s inevitably commercial pressure to rush towards the next assignment. That is why most advisors only work with ongoing clients.
Advice laws need to change
As we learnt from the Royal Commission in 2019, financial advice laws have done little to protect people from dodgy financial advisors. Now that investment commissions (vested interests) have been banned, laws need to be re-written.
The ‘compliance’ cost of providing advice is way too high. If I know what a client should do and the best solution is obvious, I would like to be able to give them this advice without needing to fulfil onus and valueless compliance obligations (such as drafting a 30-page document). The ability to do so would reduce the cost of providing advice and consequently make it accessible to more people. The government (ASIC) is aware of this and has recently announced it will waste time and taxpayers’ money on a project to identify the cause – even though the answer is obvious!
What are your options if paying for advice is uneconomical?
If it’s not economical for you to pay for personalised advice (i.e. cost is greater than the value), then there are a few alternative resources available to you.
Of course, you can educate yourself – there are lots of great blogs and podcasts that are available for free. And of course, books include a wealth of knowledge for only $30.
Some of the industry super funds (such as AustralianSuper) have their own financial planning teams that offer fee-for-service advice. This can be an economical means of obtaining once-off financial advice. Of course, they are not independent (from a super perspective), and probably don’t provide advice in respect to direct property.
If you would like advice in respect to investing in shares, Vanguard’s website has a plethora of valuable information and its diversified index funds are worthy of consideration (which you can invest in for free via its new Vanguard Personal Investor service).
Give equal consideration to both ‘value’ and ‘cost’
Financial advice can be incredibly valuable – a lot more valuable than it costs – as long as; (1) there’s enough scope for the advisor to add value; and (2) you select the right advisor (i.e. experienced, astute, independent and holistic). Yes, it can be expensive but that is only one side of the coin.