Some financial advisers have revealed how much they're going to charge in fees for investment, share ISA and pensions advice after commission is banned from January 2013. The big question is: Are the fees worth it?
A re-cap about the commission ban
The ban on commission has been lambasted by a large number of advisers, but it's actually excellent news for customers. The change forces all advisers to be more transparent with their costs instead of burying it in monthly contributions. This makes it easier to establish whether an adviser's costs are worth it for you.
The commission ban is also having two fantastic knock-on effects. It's improving advice, because it greatly reduces any bias advisers have to sell you an investment fund just because they receive more commission for them.
Secondly, the ban is pushing down not just adviser costs, but the cost of the investment funds themselves – even for those who don't use advisers. This is because fund providers are now scrambling to make their funds more attractive in a world where they will find it much harder to bribe advisers to sell them to people like you and me.
How much advice will cost
Few local advisers reveal their costs publicly. Like many other services, advisers prefer to get you in the door first, and talk about your needs and their offering before they unveil their prices.
In my table below, you'll see what two different advisers will be charging next year compared to what you'd typically pay under the old system of commission payments.
To start with, I'm going to assume you've got £5,000 to invest in a share ISA or pension right now. Any up-front costs that you have to pay to the adviser will come out of that money. In addition, I'm going to assume you plan to invest £250 per month for 30 years.
That's a very basic savings plan and your own situation is likely to be different, and certainly not that steady. But let's keep it simple.
What the advisers charge
In my table below you'll find the old, commission-based adviser, who typically took 3% of every contribution and lump sum you made and, in addition, took 0.5% of your pot every year. Note, this is 0.5% of your total pot, not 0.5% of your annual gains. The adviser would take 0.5% even if your investments did badly.
The table compares this with Adviser 1, who gets two columns depending on whether you pay for one-off advice or ongoing advice. Adviser 1 has said that, from January 2013, it will charge £490 up front. It will also charge £30 per month if you decide you want ongoing advice.
Adviser 2 also gets two columns for the same reason. It will charge £2,000 plus 1% up front and, for ongoing advice, it will take 1% of your total pot per year – double that of the old system.
As with the old system, ongoing costs for both these advisers are paid regardless of how well your investments perform.
Advice costs over 30 years – £5,000 lump-sum and £250pm
|
Estimated cost to you |
Old commission-based system |
Adviser 1 with one-off advice |
Adviser 1 with ongoing advice over 30 years |
Adviser 2 with one-off advice |
Adviser 2 with ongoing advice over 30 years |
|
Direct advice costs* |
N/A |
£490 |
£10,800 |
£2,020 |
£18,940 |
|
Estimated maximum total real cost when including lost investment potential |
£16,500 |
£1,000 |
£17,000 |
£4,000 |
£26,000 |
|
Estimated maximum total cost as a percentage of your future after-inflation gains |
30% |
2% |
35% |
9% |
53% |
Note that both the advisers appear to have some unspecified potential extra costs on top, although I would expect they are minimal in comparison to what is shown here.
Look along the third row showing the estimated maximum total real cost. As you can see at a glance, the costs vary a great deal. On the old commission basis, you might expect the advice to cost you around £16,500 over 30 years. As you can see from Adviser 1, if you choose to have ongoing advice now you might end up paying a similar figure. Meanwhile, Adviser 2 could cost you £10,000 more.
The last row shows that this could work out at around one-third to half of your real gains over the years. This means that you'll expect your investments to grow by inflation plus some more, and the adviser could take one-third to one-half of that “plus some more”.
If you choose not to get ongoing advice and just get initial, one-off advice, the costs are much lower, at perhaps 2% to 10% of your real (above inflation) gains. Expect advisers to give you a strong sell that you take their ongoing advice, since that's where they really make their money. You might pay for “one-off” advice several times over the years anyway.
The investment gains aren't shown here but, to give you an idea, you might make around £50,000 in profit over the 30 years, before adviser costs. That's on top of your inflationary gains. Of course, depending on how your investments perform, your actual end figure could vary dramatically.
Why the cost to you is so fuzzy
Lots of things can effect the cost – not least how you define “cost”. That's why there's a big difference between the direct costs and the maximum cost shown in the table.
The second row in the table (the one underneath the title row in bold) shows the direct advice cost, which is the actual amount that your adviser might receive from you. This is the cheapest definition of advice costs.
This could be an appropriate definition for you if you would have frittered away the fee had you not paid it. If you merely spent that money in the shops or on a holiday straight away, rather than saving or investing it, the direct costs are a pretty good representation of your total costs, although they're not adjusted for inflation.
However, if you would have saved or invested the fee, the total cost to you is potentially much higher. Those fees, invested for you instead of paid to an adviser, would probably have generated big gains for you over the years.
The third row shows the estimated maximum total real cost if you would have invested those fees instead of paying the adviser.
The fourth row shows the same information, but estimated as a percentage of your investment gains. As already explained, this could be between one-third and one-half of your real gains above inflation, and after other investment costs, but much lower if you just get one-off advice.
The reality for many investors will be somewhere in between the direct costs and the estimated maximum, depending on what you would have done with the fee money instead. If you would have saved it in a savings account, for example, your costs would probably be higher than – but closer to – the direct costs, because you would not expect to make as many gains in savings accounts as in investments over a 30-year period.
Financial advisers will be fuming
Lots of advisers will be fuming with my example and could well post strong defences in the comments section below. Many in the advice community do not consider it fair to measure its cost in terms of lost investment gains.
They're sometimes right. As I said, many of you would have simply spent the fee money anyway. In addition, advisers will probably say that people will choose bad investments if they try to go it alone. This is also often true.
However, I have seen quite a few advisers admit, over the years, that anyone taking a simple strategy can handle their own money as well as they can. Investing in a few index tracker funds regularly, every month, through good times and bad, for many years, keeping a close eye on your costs, and you're likely to do better than the vast majority of investors – including those who pay for advice. Indeed, you have an advantage over them, since your costs are lower.
You also have to ignore the totally mindless media, which encourages you to buy during bubbles and sell during panics, in actual fact the reverse of what you should be doing. That's the very tough part where advisers can really earn their corn – helping you keep your head.
That's not to say that all financial advisers are immune. As investment fund provider Vanguard writes in its guide Financial Advisers: How they can Help: “Finding good unbiased financial advice can be a real challenge.”
Is the cost worth it?
Unfortunately for advisers, they have a large number of big costs. This is not just staff and offices, but ongoing training, regulatory costs, insurance costs, admin costs and other burdens that are added to every year.
That said, you shouldn't pay a high cost out of sympathy. You should just pay if the advice you get is worth the price.
The cost of advice becomes more worth it the more likely you are to panic, trade too much, fall for scams, or otherwise do something silly with your money. Always check on lovemoney.com's Q&A or other internet discussion forums before signing any advice contracts, as a final check before going ahead.
Notes for advanced investors: For my calculations, I have assumed lower investment gains than most people would, at a real return of 2.5% after investment costs (but before advice costs). Even so, these are roughly in line with lots of studies, especially the excellent research and analysis from the London Business School professors Paul Marsh, Mike Staunton and Elroy Dimson, authors of Triumph of the Optimists: 101 Years of Global Investment Returns.
If anything, I worry that my projections are too high, especially considering our propensity to overtrade.
I have assumed that you invest in cheap trackers.
I have also assumed inflation will average 3.5%, which is not unreasonable based on the long-term history, the nation's serious debt problems, and our Government's willingness to print its way out of trouble.