Everything That’s Wrong With The Way Most Financial Advisers Charge…

Everything that’s wrong with the way most Financial Advisers Charge…

By

Rikesh Bhatt, Director of 8FP and Financial Planner

 

 

When I set up 8 Financial Planning, one of its core aims was to move away from charging advice fees as a percentage of a client’s investments. Instead, I wanted to charge a fixed fee based on the time required and value I can add.

Even though charging fees as a percentage is the way most Financial Advisers operate in the UK, I strongly believe it’s time more clients and firms looked for a better, fairer way.

What is Percentage Based Charging?

When you first work with a financial adviser, you are often charged one-off, initial advice fees. These cover the initial research, advice and set up of your investments. 

After this, annual ongoing advice fees are charged to cover the cost of changes that may be required to the advice, as well as annual reviews ensuring your plans remain on track.

These fees are charged as a percentage of the investments. 

How is this a negative?

The method of working out how much to charge can be both damaging, and intrinsically unfair, for most clients with higher investment values. 

For example, let’s base this on a £500,000 investment. According to FCA research* published in December 2020, average charges look like this:

2.4% Initial Advice Fee on £500,000 = £12,000

0.8% Ongoing Advice Fee on £500,000 = £4,000

This means somebody investing £500,000 is charged ten times as much as somebody with £50,000.

Why does Percentage Based Charging even exist?

The idea of charging a percentage is a throwback to a time when charges were paid via the investment company as a commission to the Adviser. 

When the use of commission was banned under the ‘Retail Distribution Review’ in 2012, lots of advisers moved from a commission set-up to a fee set-up but retained the same percentage charging approach.

This isn’t helped by the wider Financial Advice industry, who use percentage based charging throughout its entire infrastructure – Investment Providers, Platforms, Insurers and even the FCA often charge as a percentage. This makes continuing to charge clients in this way all too easy.

If it’s unfair, why do clients often agree to it?

Quite simply because it’s an easier conversation for a Financial Advisor to have with you. It fits the cognitive biases we all have. In the above example, which option sounds better? Being charged 0.8% of your investment or being charged £3,500 per year?

You’re going to pick 0.8% as it sounds less but this doesn’t benefit you if you have a higher investment value.

Advantages of Percentage Based Charging

This approach could be argued as useful at a time when you are at the starting point of your investment journey. For example, if you are investing £5,000 for the first time, it may be more cost effective to be charged as a percentage rather than a relatively large, fixed fee.

If you are using a traditional Financial Adviser who agrees to this work and charges percentages, there is a good chance they cannot provide their full services, profitably anyway. 

This is where ‘Cross Subsidy’ comes in. This means the Financial Adviser needs other, larger value, clients to subsidise the cost of providing advice to the clients with lower fund values.

Not a good result for all parties concerned.

For these types of investment values, online investment platforms that work directly with clients, such as Vanguard, could be a better solution for the Client and the Adviser.

Disadvantages of Percentage Based Charging

*It’s important to note these are all based on real-life client scenarios and this list is not exhaustive:

• The amount charged is not proportional to the cost of delivering the advice.

Under percentage based charging, a client investing £500,000 is charged ten times more than a client investing £50,000. However, the cost of delivering advice is not ten times as much.

Developing Financial Plans, conducting research and putting together the advice is often a fixed time cost. If a wider range of more complex solutions are required, then charging a fixed fee based on complexity seems a much fairer way of doing things.

• Advisers may recommend clients invest more than they should.

It’s important to earmark a good proportion of a client’s assets in cash. Knowing interest rates are very low and inflation is high, this is still the right thing to do to ensure clients hold cash for emergencies, planned spending and market falls (if drawing income).

However, the more you invest, the more the adviser earns as a fee. As you can see, this creates a bias that can lead to poor client outcomes.

• Advisers may recommend clients hold onto more of their investments than they should.

Good Financial Planning is all about using your investments to make a positive impact in your life. For example: Clearing your mortgage, retiring sooner, spending more on the things that matter, helping children with house deposits or education.  

However, percentage-based charging creates a conflict here. Does the adviser recommend these actions knowing it could significantly impact the ongoing advice fees they will receive?

• The sustainability of financial advice firms.

Financial advice firms need to remain solvent and profitable so that they can be around to support clients during the important stages of their lives for decades to come. To do this, they need steady, reliable income that allows them to plan their own finances. 

In March 2020, when investments fell by up to 30%, firms that relied on percentage based charging found most of their income reduced by the same amount, but they retained the same cost base.

Whilst this was temporary, this calls into question the long-term sustainability of firms, especially during more significant and sustained market falls.

Why I feel Fixed Fee Charging is a better way

To break the link between the value of investments and the level of fee, I advocate a fixed fee approach for fund values over £500,000. These should reflect:

• The time required to deliver advice 
• Complexity of client circumstances
• Value that can be added by the advice

This approach has several advantages: 

• This also allows clients to know, up front in £, what they are paying for advice and what they should get back in return. This builds trust and avoids surprises meaning fees are upfront, fair, and clear. No surprises. 

 

• Advice can be put together based the client’s needs rather than being influenced by how the advice would impact the fee the client would pay. 

 

• In the long run, fixed fees that are inflation linked mean you often pay less than percentage-based fees – See the example below:

 

In an example where £500,000 is invested, over a 25 year term, that grows at 3% over inflation…

Adviser A charges a fixed, ongoing advice fee of £3,750 per year. This is inflation linked.

Adviser B charges a Percentage based fee of 0.75% Per year. 

Worked out over 25 years, the client being charged fixed fees saves a total of £40,031 in fees compared to the client paying a percentage based fee.

 

In Summary:

We are proud to be a firm that aims to modernise the way Financial Advice is delivered in the UK. If points in this article have got you thinking, I would encourage you to get in touch to learn more about what we do and how we do it.

*https://www.fca.org.uk/publication/corporate/evaluation-of-the-impact-of-the-rdr-and-famr.pdf

Rikesh Bhatt, Director of 8FP and Financial Planner