Dear Reader,
Matthew Morris, a former Independent Financial Adviser claims to have made a discovery:
“More than £100bn is invested in funds where the fees charged have outstripped investment returns over the past 10 years.”
What’s going on? Can it be true - an IFA attacking his own industry and exposing the dire performance of so many investment funds?
Well no, not really. He’s launching a new website and wanted a bit of free publicity. If you’re interested, you can read all about it here. Instead of flogging investments to the public, his new business is flogging IFA’s to the public… not much change there then!
It’s not the self-promotion that rankles with me, but the hypocrisy of his argument. The fact is that it’s often IFAs that put clients into these terrible funds in the first place. On top of that, a good proportion of the fees fund mangers charge end up flowing back to…. yes you’ve guessed it, the IFA…
Blithely ignoring the culpability of his own profession, Mr Morris sanctimoniously expands “Investors need to start switching from fund managers who don't offer a commensurate return on their investment”.
How disingenuous can you get? IFAs put people into these funds, so why don’t they switch them back out if the funds underperform – that’s what they’re paid for isn’t it?
Ah. Well, unfortunately no it isn’t.
How the IFA business model really works
Let’s take a closer look at how things work in the world of the IFA.
IFAs have two options for how they charge their clients for their advice. They can either charge an up-front fee, or a commission-based fee. Very few charge upfront… Why? Because it’s much more lucrative to earn commissions.
In fact, there are two types of commission that flow back to the IFA from the fund manager. Firstly the initial commission: To the IFA this is useful, an upfront fee that goes towards his operating costs. Then comes what I would call the cream. These are the annual trail commissions, varying from 0.1% to 0.9% of the client funds. As the name suggests these recur every year.
These are income streams stretching way out into the future. Imagine a young client starting up his pension fund, he could be committing for 40 years or more! What’s more if he keeps adding to his pension pot these commissions get larger and larger.
Future income streams are worth a fortune to the IFA, and better still there’s very little work involved. It’s like having a money printing press.
Now, is the IFA likely to pull a client out of a fund simply because it’s performing poorly? Or is he likely to stick with fund managers that provide the best commissions and invite him to those all expenses paid days out? Hmmmmm.
As Merryn Somerset Webb of Moneyweek has frequently argued, IFAs should be paid up front by clients for genuinely independent financial advice. The idea that they can take commissions from the industry and remain truly independent is curious.
Drive a hard bargain with your IFA
For the sake of completeness, I’d like to point out that not all IFAs take the maximum commission they’re entitled to. If you shop around, you will find some that rebate part of the commissions they receive. So if you already have an IFA, be sure to question their commissions. Drive a hard bargain when it comes to the issue of rebates.The FSA is working towards greater transparency and new initiatives mean that IFAs have to tell clients about commissions they earn. And IFAs have to offer clients the option of paying up front for advice. The ridiculous thing is that clients are rightly advised against this route. If you pay for their service up front, all that happens is the fund manager pockets the IFA’s commission and the client ends up paying double. Another own-goal for the FSA!
If the FSA really wants to tackle this issue head-on, I would like to make a practical suggestion. Get rid of the term ‘Independent Financial Advisor’. Replace it with ‘Commission Driven Financial Salesperson’ - that should make things a little more transparent.
To avoid seeing your funds frittered away by management charges and IFA commissions, take matters into your own hands. Use a standard stockbroker, SIPP and ISA for your investments.
Invest directly into ETFs, investments trusts, or if you want, create your own portfolio of individual stocks – after all, there’s no evidence to suggest the professionals perform any better than you can. And if you’d like some great ideas for stocks to buy, then just take a look at our stable of specific stock market advisory newsletters here. There is bound to be something that suits your style.
If you do want to buy a unit trust, or OEIC (regulated products), then use a discount fund supermarket – make sure you get your commission rebates.
By the way Mr Morris’s new venture is ‘How much do I need to retire’ (www.howmuchdoineedtoretire.co.uk). I don’t know, but I guess the IFAs will get there before most of us!
Good investing,
Bengt Saelensminde
For The Right Side
P.S. Remember to take a look at our broad range of stock market newsletters. From the exciting high-risk/high-reward world of penny shares to the long-term strategy of high yield dividend investing, we have an expert for most investment appetites. For full details, follow this link.
And if you're looking to open a spread betting account compare the top twenty with MoneyWeek's Spread Betting comparison table.
P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.
