Ban percentage fees to fix the advice industry

The Australian 12:00am April 21, 2018

Alan Kohler

It’s perfectly understandable that AMP’s and CBA’s financial planning arms kept charging fees when no services were being provided — even, in the case of CBA, to the long deceased — because there is very little difference between providing financial advice and not providing it.

Financial planning services, especially those provided by the banks and AMP, have always been a joke, and it is beginning to look like His Honour Kenneth Hayne, royal commissioner, is going to so find. It is almost as big a joke as the statement in the royal commission’s terms of reference that Australia boasts “the strongest and most stable banking and superannuation systems”, and “world’s best prudential regulation and oversight”.

The fact that financial advisory practices were continually referred to in the commission this week as “dealer groups”, which is what everyone in the industry has always called them and still does, rather gives the game away. They don’t see themselves advisers, but groups of dealers.

And the Financial Planning Association revealed another giveaway this week: that only 35 per cent of financial planners have a degree (while boasting that 60 per cent of its own members do have one, although a degree in what is not explained). Two-thirds of financial planners, according to the FPA, just completed high school. Anyway, the specific service that AMP and CBA are accused of not providing is an annual review by one of these skimpily educated financial planners. How long would that take per client? Two hours? Three? Even a whole day?

Advice fees are usually around 1 per cent, often more, and that’s before the investment management fees go on top. That means a retired doctor or professor with $5 million invested is paying at least $50,000 for an annual once-over from a person far less qualified than themselves.

It is very difficult to see, after this week’s events, how Hayne can avoid recommending the total abolition of The Clip — that is, percentage fees.

Every link in the investment industry chain takes a percentage clip — custody, administration, advice, asset allocation, execution. It is this system that creates the corruption now so evident. Providing investment services are simply too lucrative and the money is too easy to make. Moreover, it is based on a fundamental misconception: clients believe they are getting advice, but the advisers know they are actually members of “dealer groups”, paid to deal, not to advise.

All financial services should be invoiced, so that clients can see the cost and assess them against the value received, as they do with all other services — not just by reading the fine print of a compliance statement on the website. The Clip is only able to happen with investment services because the providers actually get to hold their clients’ money. Other utilities can only dream of such a wheeze.

Huge fees that sound small as percentages (“only 1 per cent”) are deducted in return for virtually nothing: in most cases, little more than an annual cup of tea and a chat, and a reassurance that everything is going fine.

The initial consultation and Statement of Advice is usually billed separately, upfront.

Think about an ordinary retired couple with the $1.6m they are allowed to have before losing tax-free status. They’ll be paying about 1 per cent of that per annum to an adviser, who adds it to his or her FUA (funds under advice). That’s $16,000 per year per client, $1300 a month, month after month, year after year.

It means financial advice is by far the most expensive service that most Australians buy. It usually costs more than every other monthly bill put together.

What’s more, it is an essential service, effectively mandated by law. Saving for retirement is mandatory, which means investing it when you retire is also mandatory. The ACCC regulates the prices of other essential services, but not financial advice.

It’s true that you don’t have to use a financial adviser, and many people don’t, but for most people it’s not really optional. Self-managed super funds have been the fastest-growing part of the industry for many years, it’s true, but they’re mostly mislabelled. Most SMSFs use an adviser.

Then there are the administration platforms. They generally clip 0.5-0.7 per cent, which means our couple with $1.6m are paying $10,000 a year for that. The marginal cost of providing that service is virtually zero, the profit margin after break-even astronomical. Imagine getting a monthly bill for $1000 from a mysterious utility named Netwealth or Hub 24 and sitting down to do a BPay for that amount, every month. Nobody would do it.

In my view the only one of the various snouts in this trough that can remotely justify percentage fees is the snout of the investment manager — assuming they are actually making decisions, of course, and not just investing in the share index, which they often are, while still taking a (smaller) percentage. In that case a percentage fee can perhaps be justified as providing an incentive for better performance, except it should be a percentage of the return, not the total sum.

Charging a percentage of the total sum for investing money means the fee hardly changes no matter how good or bad the service is, and The Clip increases each year with the size of sum.

That is the fees increase at the rate of the investment returns, not inflation or wages growth. Inflation is less than 2 per cent, wages growth 2.1 per cent, but passively investing in the sharemarket over the past 20 years has returned 8.3 per cent per annum, which means that, on average, The Clip has been increasing at that rate as well.

Percentage fees is the dirty secret at the heart of the corruption of financial services. Regulation will never fix the problem until it is abolished.