Do you know how your adviser gets paid? You should. Source: https://pixabay.com/
Financial advisers can earn their money in different ways, some less favourable to your financial health than others. Remuneration models have evolved over the years as the financial services industry has become more sophisticated, diverse and consumer orientated.
Do you know how your adviser gets paid? You should. It is incumbent on your adviser not only to disclose the costs of the financial products you sign up to, but how he or she will be remunerated and how much that remuneration will be. This can be negotiated up front.
There are three basic remuneration models, although advisory practices may employ a combination of these:
Commission-based. This is the traditional model used for decades by the insurance industry. The adviser receives a commission from the product provider on each financial product sold. It may be an upfront commission, an ongoing annual commission over the life of the product, or both.
AUM-based. AUM stands for “assets under management”. The term generally applies to investments but not other types of financial products, such as insurance policies. Here, the adviser receives a percentage of the value of your investments annually, typically after taking a higher initial fee. For example, there may be an initial 3% charge on your investment followed by an annual 1% charge.
Fee-based. Under this model, you pay the adviser directly, as you would pay directly for a consultation with a doctor or lawyer. There are various ways in which this can be done: the adviser could charge a simple per-hour rate or have fixed charges for certain services.
Rory Brachner is founder of the online advisory platform DoshGuide. DoshGuide represents a new version of the fee-based model whereby, for a monthly subscription fee, you enlist the services of a professional adviser on the platform.
Brachner says each remuneration model has its pros and cons, but ultimately it is the third that best serves your interests. Taking each model in turn, he looks at how aligned the adviser’s incentives are with those of you, the client.
In the commission model the incentives of the adviser and client are highly misaligned, Brachner says. “Misalignment occurs because advisers are rewarded for pushing products rather than solving for the needs of their clients. Not all clients need financial products, but advisers operating under this model can’t earn a living offering product-free advice, such as advice on reducing debt,” he says.
In the AUM model, there is a moderate misalignment of incentives. “In some ways this structure has better alignment, since advisers are incentivised to grow the assets under management in order to earn higher fees. However, misalignment does occur, because the remuneration is tied to the investment. For example, the adviser may be reluctant to clients pulling their money out, even when it makes sense to do so,” Brachner says. He says the adviser is more likely to focus on your investments, neglecting other areas, including fundamental advice on managing your money, and the model is more suited to the higher-net-worth market where clients have large amounts to invest.
Which brings us to the fee-based model. Here, the incentives of you and your adviser are fully aligned. “Advisers aren’t rewarded for pushing products or collecting assets and can only increase their reputation and business by providing great, objective financial advice. They work for the client, not a financial services provider. If a client ends up needing a financial product, they can advise on that too, but there’s no incentive to sell,” Brachner says.
The main reason this model is not more popular is that it involves a direct fee, unlike the other two, where, although you might agree to the percentages, the fee doesn’t come off your bank account.
But ultimately, you pay less and gain a great deal more if you pay directly. Commissions and AUM fees work out very expensive when you do the maths. For example, 1% of an investment of R1 million is R10 000, while an initial fee of, say, 3% is R30 000. So in the first two years you’re actually paying your adviser R40 000. Over the long term the cost can be staggering. The difference between a 4% and 5% annual return over 20 years on a R1 million investment is R462 174. And that’s on just one investment product. You also save on zero commissions on insurance products. And because you're getting better-quality advice, you benefit in innumerable other respects.
DoshGuide offers subscriptions starting at R850 a month, which Brachner reckons is within the reach of young professionals. For less than the cost of a DStv Premium subscription you get the services of an independent Certified Financial Planner and member of the Financial Planning Institute – these are the top-echelon advisers in South Africa.
“The subscription version of the fee-based model has gained strong traction in markets such as the US and UK. In South Africa adoption is at an early stage, but is also seeing strong growth due to interest from younger clients and a small innovative community of advisers that have shifted to this approach,” Brachner says.