Financial planning is an industry riddled with compromise, cosy deals
and the kind of flimsy standards that would be unacceptable in any
other sector. The industry would like to see itself as a profession, but the
continued existence of these issues means the term “profession” is not
yet appropriate. It’s time to look at the flaws at the heart of
financial planning.

  • When most people enter into a relationship with a professional
    financial planner, they expect to be dealing with a highly qualified
    professional who will be able to guide them towards their financial
    goals. It is worth understanding that the minimum standards for
    financial planners are very low compared to other professions, such as
    teaching, accountancy, law and medicine. Of course, it is not as though you can get the basic financial planning
    qualification, the Diploma of Financial Services, in a week. It will
    take at least eight days.
  • Financial planning should be about successfully investing your money;
    too often within the financial planning industry it quickly broadens to
    include personal borrowing. “Gearing” — borrowing funds to expand your
    investments — is not for everyone yet it is pushed as a panacea by many
    planners. Why? Because the more you borrow, the more the planner makes from you.
    It’s simple: once you “gear” your portfolio the planner gets
    commissions on the enlarged amount. Consider the way a simple financial strategy such as borrowing to
    invest is corrupted by commissions. If a client with $100,000 to invest
    approaches a commission-based financial planner, they may be urged to
    go for a wrap service and managed funds that pay total commissions of
    1%, or $1000 a year. However, the financial adviser may just as easily recommend that the
    client borrow a further $100,000 using a margin loan and invest
    $200,000. While the client is lured by the larger tax deductions they can get
    from their geared portfolio, the planner now receives 1% commission on
    $200,000 plus another trailing commission of 0.5% on the margin loan,
    $2500 a year in total.
  • Most reasonably astute people now understand that upfront and ongoing
    commissions paid by financial service products such as managed funds
    and insurances have the potential to influence planners’ advice. The
    “‘structural corruption” in the financial planning industry runs deeper
    than this, and the following are two further examples worth keeping in
    mind. Most sections of the financial services industry express their fees in
    the form of percentages. Managed fund fees are expressed in
    percentages, as are wrap account fees, industry super fund fees, and
    trailing commissions. Even many independent financial planners express
    their fees in percentages. The risk of this is that investors will look at a percentage-based fee,
    and not really comprehend the impact the fee is having on their
    expected investment returns. For example, the average long-run return
    from Australian shares has been about 12% a year. That means that
    paying 1.8% for a fund manager to manage your Australian share
    portfolio is equivalent to paying 15%, or close to a sixth, of your
    expected investment returns for that management. This is a significant
    portion of your expected returns. Think about it: imagine you invest
    $180,000 into a fund with an MER of 1.8% — over ten years you’ll pay
    $32,400.
  • To call yourself an independent financial planner requires that you are
    not owned by a financial institution and you do not keep any payments
    from financial products (such as commissions). Commissions that are
    received need to be rebated to clients. An “independently owned” financial planning firm is not “independent”
    if it bases its revenue on accepting commissions from financial
    planning products.
  • Managed funds have been the core of the financial planning industry.
    They are a simple way to manage money that usually pays the planner an
    ongoing income stream, in the form of a trailing commission, for the
    life of an investment. It also sounds great for the client: they have a
    professional fund manager taking care of their money! The only problem
    is that it does not work particularly well. Managed funds, particularly
    the large managed funds run by big financial institutions, do not add
    enough value to cover their fees.
  • One
    of the least-known and most controversial issues within the
    financial planning sector is the buyer-of-last-resort agreement between
    planners and product-selling institutions. It allows the business to be
    sold to the institution as a “last resort” and has acted as a de facto
    insurance policy for many planners; the downside is that it promotes a
    distinct bias towards the institution during the life of the business.
    Buyer-of-last-resort agreements mean a financial institution pays a
    planner a “capital value” for their business when they retire. The
    value is based on the level of funds they have placed with investment
    managers, often with higher levels paid for the funds placed with the
    financial planner’s institutional owner. The agreement effectively
    encourages advisers to recommend in-house products to increase the
    capital value of their business

Peter Fray

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