One of the main arguments made by Australia’s banks for the watering down of Future of Financial Advice (FoFA) reforms is that it would reduce the cost of financial advice to consumers.
Specifically, the banks want “general advice” to be exempt from the rules prohibiting conflicted remuneration - in other words, commission.
The presumption is that the cost of financial advice is too high. But what are the costs? The short answer is it varies, depending on the complexity or amounts involved.
At a minimum, a client may expect to pay about A$1,500 for a comprehensive personal financial plan and more likely $3,000 or more. Then, an agreement may be put in place to charge an amount for an annual review and monitoring services (in other words – a retainer).
Let’s take an example where a consumer has a relatively small sum of $5,000 to invest. Under the law, a financial adviser is required to treat the consumer for “personal advice”. This means taking into account the person’s details, risk profile and objectives and then completing a “statement of advice” which may run to some 15 pages or more.
To comply with the Corporations Act, the adviser may need to spend some 4 hours or more to complete the task to the required degree. If an adviser charged $150 per hour (cheap by all accounts) then the cost of providing the service would be about $600 or 12% of the investment amount. If the hourly rate was $300 then the amount would be $1,200 or 24% of the invested amount.
Such cost levels are obscene when considered as a percentage, and have made financial advice inaccessible for people with small amounts to invest.
Prior to July last year, advisers often received commission payments from product providers allowing them to waive or reduce the upfront fees charged for advice. From July 2013 financial advisers were banned from receiving commissions for new advice, in order to ensure the advice was not biased.
A recent example of the effect of the ruling is when a member of an industry superannuation fund retired and wanted to commence a pension from his fund and was charged $1,500 for a financial plan just to make a change to his circumstances. Such a fee can be explained by the rules of compliance under which financial advisers must operate.
The case for simplification
So, in such a context, the government’s proposal to simplify things by reducing the compliance rules makes sense. The new regime would allow some advisers to waive the normal requirements of giving objective advice after considering the consumer’s circumstances by allowing “general advice” to be offered instead.
This means the financial adviser will not have undertaken an account and have recorded all details of the consumer’s personal circumstances, and the recommended investment product will not necessarily be selected for a specific purpose that meets the consumer’s investment objectives. The advice is “general” so it may not be specific for purpose.
The upshot of all this is that some advisers will change their way of doing things to comply with the rules for providing general advice, so they will not be required to complete a client risk profile or produce a time consuming statement of advice. And the benefit to be derived is the payment by way of commission.
In the earlier example of the investment of $5,000, a commission of 3% or $150 may seem to be a saving to the consumer compared to paying $600. But, if the investment was $20,000 then the commission would be worth $600 without the adviser having to comply with the personal advice requirements. If the investment amount was $50,000, then the commission amounts to $1,500. At that level, we might as well return to the old days when selling a product was the objective.
Ongoing commissions are still rife
There is another aspect to financial advice costs that is overlooked in the current debate on whether to wind back parts of FoFA.
The costs of financial advice also extend to the costs applied against the consumer’s investments. Such costs are invariably based on a percentage of the amount invested. In other words, a commission form of fee is involved.
To illustrate: a consumer invests $100,000 via a product provider into an administration platform and then spreads the risk of investment among four or five investment managers. There are a number of costs involved.
The first is an administration fee charged by the platform provider. This is based on a percentage of the amount of funds invested, say 0.8% pa. There may also be a member fee of say, $10 per month. Then the funds are invested with a range of fund managers who charge a fee based on the size of the investment.
Such a fee can range from a conservative 0.4% to 2.2% or more and some may even include a performance fee as an extra reward to the fund manager for exceeding a performance target.
Another level of fees that may hold back the performance of the consumer’s investment is an adviser’s ongoing fee. Again, in some instances this is also levied by means of an asset-sized fee up to 1% for various adviser services, although some advisers levy a dollar amount for such service rather than an asset-based percentage.
There are many stakeholders involved in the current debate about financial advice fees and commissions – consumers, advisers, regulators and product providers. Notably, the first three are opposed to the changes currently being considered by the government.