We have all read the horror stories in the newspapers or seen them on television: Mum and Dad put their trust in a financial advisor. The advisor ‘sells’ them an investment that paid him a substantial commission. The investment was poor quality. Mum and Dad subsequently lose their life savings and the advisor goes unpunished. A new story like this comes up every few months. It’s frightening and very upsetting!
I propose you can only do one thing to eliminate 99.9 per cent of all these stories occurring: remove all and any conflicts of interest. Once all conflicts of interest have been removed, working out if you should and can trust a particular advisor becomes a lot easier. In that situation, it simply comes down to whether the advisor has enough experience, knows what they are talking about and has a track record of producing good results.
Let me put it this way, would you be comfortable if your doctor (GP) was employed by a pharmaceutical company? Absolutely not! And that is why laws in Australia prevent pharmaceutical companies from owning and operating medical practices. I believe that we should have similar laws in the financial services industry (but I suspect the banks’ political lobbying power will prevent this from happening). How do you choose which GP you visit? You make an assessment of whether the doctor knows what they are talking about, the results they produce and whether you feel comfortable dealing with them.
Therefore, before concluding that all financial advisors are crooks, I invite you to recognise that two types of financial advisors exist: independent advisors and conflicted advisors. When you read the next horror story in the newspaper ask yourself whether the advisor was independent or conflicted. I’ve no doubt you’ll find they are always conflicted. The golden rule here is that you should always avoid conflicted advisors.
You should never, ever take financial advice from someone who has a conflict of interest. Doing so would expose you to significant risk – and it’s just not worth it!
To be truly independent I believe the advisor needs to satisfy five conditions
1. Take no investment commissions, referral fees or kickbacks
The advisor should not accept any investment commissions, referral fees or any incentives for recommending any particular investment/s. This ensures they are impartial and have no personal stake in the advice outcome. They shouldn’t make any more or less money (fees/revenue) based on their recommendations – irrespective of whether they recommend you invest in property, shares, super or nothing at all!
2. Offer fixed fees
They should not charge you a percentage fee on your investments because this creates a conflict too. Independent advisors should charge you a fixed monthly, quarterly or annual fee for their service (or an hourly rate is fine too).
3. Have no investments to sell you
The advisor’s business shouldn’t make money from selling investments. For example, some financial planning businesses operate their own managed funds – that is not good. Some businesses will have relationships with property developers and receive commissions from recommending properties to their clients – this is definitely not good and you need to steer well clear! Some financial advisory practices offer the services of a buyers’ agent – so if they recommend you invest in property, the buyers’ agent can help you buy the right property for a fee. This, of course, creates a conflict of interest. This arrangement might not be a deal killer (and I know of at least one business that does this ethically), but beware that it is higher risk. The best case is that the advisor’s business has nothing to sell you. They don’t operate their own managed funds (shares), recommend direct shares (like a stock broker) or buy/recommend specific properties (through a buyers’ agent). And they definitely have no links with property developers!
4. Be privately owned with an AFSL and with no links to banks or investment providers
All financial advisory businesses must have an Australian Financial Services Licence (ASFL) by law (or be authorised by an AFSL holder). The AFSL holder can direct advisors on which products/investments they can and cannot discuss and recommend. Therefore, it is important that the licence owner is an independent and privately-owned business. If the AFSL owner is a bank, for example, the advisor might only be allowed to sell bank-owned products (or have a very narrow list of other products).
5. Demonstrate deep knowledge of all asset classes (especially property and shares)
It is important that an advisor has a robust understanding of how to invest successfully using any and all asset classes. The main asset classes in Australia are residential and commercial property, shares/equities, bonds and cash. However, some financial planners know very little about investing in residential property. So how can they sit in front of their clients and recommend they invest in shares? My view is that they should know both property and shares equally well to be able to reach a reliable conclusion. If you walk into a Ford dealership, they will sell you a Ford. If you walk into a Holden dealership, they will sell you a Holden. If you visit an independent dealership, they’ll likely know Ford and Holden cars equally well and, therefore, be able to recommend which one suits your circumstances best. To deliver independent, reliable advice with high integrity you must have a thorough understanding of all asset classes.
We passionately believe that independence is the key to quality advice
I have always held a very strong belief that independent advice is the only advice you can trust. I despise hearing about poor unsuspecting people getting ripped off by greedy sales people that masquerade as advisors. I hope that this blog gives you the knowledge to avoid such people.
The above is a excerpt from Stuart Wemyss’ new book; Investopoly – the 8 rules for mastering the game of building wealth. Click here to learn more and buy your copy online.