Simon's Blog

What should you expect from a financial adviser?

March 28th, 2012

In the wake of finance company failures and the Global Financial Crisis (GFC) many people have rightly been questioning the value of the financial advice they have received. There has also been plenty of finger pointing from within the advisory community – some of it informed, and much of it not. This article gives some straightforward answers to the important question “What should you expect from a financial adviser?”

In recent times tens of thousands of New Zealanders have lost more than half a billion dollars in finance company failures. Many have lost a lifetime’s careful savings – a nest egg accumulated over years of careful budgeting and doing without.

Some did not seek advice, and entrusted their life’s savings to a shoddy company on the basis only of a newspaper ad featuring a credible looking name and a high interest rate. Others paid for professional advice – and lost money all the same.

Following the finance company collapses, the GFC from 2008 on saw a real drop in investment values here and around the world. This has also caused investors to question the value of the advice they received and in many cases to flee to “safe” investments.

There is risk in all investments

We must be clear from the start that all investments carry a degree of risk, and that some risks cannot be predicted or guarded against. To use an extreme example, few if any investors considering an investment in central New York before September 2001 would have considered the possibility that the Twin Towers could be destroyed by two passenger planes.

Few investors would be concerned about risks of this type. But the fact remains that making any investment involves taking some risks.

Risks can be managed

However many investment risks can be avoided, managed or reduced by commonsense strategies like doing your homework (professionals call this research), and by not putting all your eggs in one basket (professionals call this diversification). Managed this way, risk can be positive for an investor – because in the end a well chosen diversified mix including ‘risky’ investments usually does better than a portfolio restricted solely to ‘safer’ investments.

Given the complexity and the risks involved, it is not surprising that many people look for professional advice on their investments. If you have paid for advice (either directly – through fees, or indirectly – through commissions from a product provider), or if you are considering getting advice about your investments, how should you choose your adviser, and what should you expect?

What does the law say?

Until 2010 there was very little regulation affecting New Zealand financial advisers. Fortunately, with the implementation of the Financial Advisers Act, that has changed.

All advisers now have to be registered, with their names on a public record, the Financial Services Providers Register (you can see this at www.fspr.govt.nz). They have to belong to an approved Disputes Resolution Schemes. They must not mislead or deceive, the must provide meet a reasonable standard of care, and provide certain disclosures.

In addition to being registered, financial advisers who give provide advice on more complex products including all forms of investment must be authorised. These advisers are called Authorised Financial Advisers, or AFAs). AFAs have to meet a number of additional requirements, including minimum levels of initial and ongoing education, criminal and police checks, and testimonials

AFAs also have to meet tough disclosure rules. In the first instance, they have to give prospective clients a ‘Primary Disclosure Statement. This contains important information to help you decide whether or not to use their services. It includes how they get paid; non-financial benefits they may receive from other organisations; and criminal convictions, and adverse findings in any court on their professional role.

When providing a particular financial service, an AFA must also give you a Secondary Disclosure Statement that with it. This details the amount of any direct cost to you, when it must be paid, and the how much your adviser will be paid as a result (other than by salary) including any remuneration from the providers of financial products.

Finally, AFAs also have to adhere to a government-approved 19-point Code of Professional Conduct (the Code). This sets out important obligations to:

put your interests first
ensure that any personalised service is suitable to you
ensure that you are made aware of the main benefits and risks of following their advice

The Code requires AFAs to demonstrate an appropriate level of knowledge, competence and skill when providing financial services, and have a professional development plan covering gaps in their knowledge and how they plan to address these.

Will the new law protect you?

New Zealand was the last OECD country to regulate financial advisers. It’s a great pity that successive governments have taken so long to get to that point – something the IFA has wanted for years. And it’s a crying shame that the finance company collapses and the GFC came along before the reforms were in place.

It’s still too early to tell whether the new regime will provide a real basis for ensuring that financial advisers act professionally. It’s all about consumer confidence. Not in the markets, which are outside an adviser’s control, but in their chosen adviser.

A major gap relates to “category 2” products such as insurance, where the requirements are much lower – including no obligation (unless your advisers is an AFA) to put your interests first, or adhere to the other requirements in the no Code.

And regulation never means the end of problems. Laws don’t change human nature. Lawyers and accountants have been regulated for years, and yet members of those professions are regularly exposed as crooks. Financial advisers are regulated in Australia, but that hasn’t stopped ordinary folk across the ditch being preyed upon by financial sharks. And the new rules don’t provide enough protection for those receiving advice on insurance, mortgages and similar products unless their advisers are AFAs (there are still fewer than 2,000 AFAs).

But regulation will mean that unprincipled and incompetent advisers, particularly investment and financial planning advisers can be taken out of business, and face real financial penalties.

And many (but not nearly all) New Zealand advisers belong to the Institute of Financial Advisers (www.ifa.org.nz), which sets standards higher than those required by law, requiring all financial adviser members to meet these (AFA or not). Some of IFA members also have the internationally recognised CFPCM credential (more details at www.fpsb.org) – you have to be an IFA member to use this credential in New Zealand. Professional body membership and internationally recognised credentials can provide added assurance to those seeking professional financial advice.

Some investment basics

Plenty of experts have commented on the finance company collapses and later crises criticising those who lost money and/or their advisers. But very few have been prepared to give clear guidelines on what investors should have done. More on that later, but first here are some investment basics.

As I said earlier the golden rule of investing is to diversify – spread things around. Generally a portfolio should consist of a mix of ‘risky’ assets like shares and ‘safer’ assets like bank deposits. More in risky assets if you have a long time frame and/or no immediate need for investment income. More in safer assets if you need an income and/or if your investment is short term.

A common mistake made by investors and advisers alike is to look for higher returns from interest-bearing assets rather than from traditional sources of investment risk, like property and shares. Unlike shares and property, interest-bearing investments only have ‘downside’ risk. They either pay you what they promised or (if things go wrong) less than that.

Shares and property both have ‘upside’ as well as ‘downside’ risk. When the share market turns down (as it often has – both here and overseas – especially in recent years) someone with a well chosen mix of shares usually only has to wait to see values come back up. With a diversified portfolio of well chosen ‘risky’ assets time is your friend.

‘High interest’ usually also means ‘high risk’, and often when an interest-bearing investment gets into trouble the only question that remains is how much of each dollar you will eventually get back. Time can become your enemy. The longer a fixed-term investment is from maturity the greater the chance of things going wrong.

There are no hard and fast rules, and it can depend on a variety of factors like those in the bullet list below. But if you had $200,000 to invest for 10 years or more, and a balanced portfolio was right for you, then about half of the total might go into interest-bearing investments of one sort or other. Of this, only a small part – if any – should be to higher-interest (read ‘higher-risk’) deposits: say no more than $10,000 (or 20% of the overall portfolio) in total.

And no matter what, unless you want to gamble, you shouldn’t put all your money with one or just a small number of high-risk (read ‘high-interest’) providers.

What should you expect from a competent financial adviser?

Before giving you any advice they should take the time to learn about your situation, needs and attitudes. In your initial discussions they would have learned key things about you:

Your time horizon (how long you were planning to invest for)
How much income if any you will need
Details of your wider situation, especially of any debt
Details of other resources, and especially of any other investments
Your experience and sophistication as an investor
How you feel about investment risk (your risk appetite), and
How much risk you can afford to take (your risk capacity).

Their advice would take account of all these things. It should also conform to the core principles explained above, including the needs to:

Diversify (even at the most basic level we all know it’s foolish to put all your eggs in one basket),
Match your personal time frame and those of your investments (eg: you shouldn’t invest short-term money in a long-term investment), and
Have a ‘reasonable basis’ (eg: advice to use – or get out of – a particular investment should be supported by an external research report, or some other robust evidence of its suitability.

And on top of that, even it is wasn’t the law, a competent adviser who is also a professional would be sure to give you all relevant details about things that might have influenced their advice – including:

The remuneration (fees and or commissions) or other rewards (including ‘soft dollar’ incentives like trips) they will get if you follow their advice, and from whom,
Any relationship or constraint that could have affected their advice, and of course
Full details of any conflict of interests (such as if the investment recommended was going to pay them or their employer twice what another similar investment would pay).

What can you do if you get poor advice?

The new regime has provided you with a number of options.

Firstly, if your financial adviser is an AFA they have to have an internal complaints process. So your first step would be to contact your adviser or their firm.
All advisers (AFA or not) have to belong to a Disputes Resolution Service (DRS), so you can approach your adviser’s DRS. How to do this must be detailed in their Disclosure Statement This is listed on the Financial Services Provider Register. Decisions made by the DRS are binding on the adviser – but not on you unless you have agreed to that.
You can also complain directly to the Financial Markets Authority, who can investigate your complaint and decide what if any action to take. The FMA has a Disciplinary Committee to deal with breaches of the Code by AFAs.
If your adviser was a member of the Institute of Financial Advisers at the time; and being paid to give you advice (rather than just to process a transaction, for example) you may wish to lay a complaint with the Institute, which says it does not protect members who breach the rules. It has independently chaired Professional Conduct and Disciplinary committees.
And while this can be very expensive you can always sue.

We all deserve a society where people can be confident in relying on those they go to for advice about investments and other financial decisions. Our new law has improved the environment for Kiwis seeking financial advice, but it will take time to really bite, and laws on their own are never enough. Keeping your wits about you, guarding against the universal human failings of greed and fear, asking the obvious questions, and ensuring that you take professionally advice when you need – commonsense habits like these will always be required.

Tags: advice, CFP, financial, financial advice, financial planning, investment, investment advice, professional
Posted in Uncategorized | No Comments »

Too conservative?

March 22nd, 2012

In a recent blog Michael Kitces produces an interesting argument asking whether financial planners tend to be too conservative when selecting the term for a retirement adequacy calculation http://www.kitces.com/blog/archives/285-Whats-Your-Longevity-Assumption-Are-Planners-Being-Too-Conservative.html.

I have some contrary thoughts.

It’s dangerous for financial planners to refer simply to population life expectancy when estimating an appropriate term for retirement adequacy calculations. I am not sure the research has been done yet, but my guess would be that the average financial planning client is likely to live longer than the population average – by dint of being better educated, healthier, and perhaps also genetically predisposed to longevity.

Another problem is that statistics can have little value when applied to specific instances. (Just because there is a 50/50 chance of tossing a head, doesn’t mean that if I’ve just tossed tail my next toss will be head.) Financial planners need to select a projection term for a particular client that reflects their client’s lifestyle, health, medical history and family background (and they need to know about these things).

Planners must also be ready to increase that term as appropriate as their clients age, moving into older (and likely longer living) cohorts.

Finally, the problem is asymmetrical. Running out of money 5 years early is likely to have more significant consequences for a client (and potentially for their adviser) than the alternative problem of having 5 years’ cash still in the bank when the need runs out. A bias toward conservatism is entirely appropriate when estimating the appropriate term for retirement adequacy.

Posted in Uncategorized | No Comments »

Can investment and other financial advisers justify their fees?

December 13th, 2011

Yes, no, and it depends.

Yes, if the fees or commissions are reasonable in relation to the value of the services they provide.

No, if the adviser (and let’s include the firm they work for here) is just ‘clipping the ticket’ – whether the ‘clip’ is taken as commission or fees. Particularly so where conflicts of interest exist (as when an adviser claims to be, or gives the impression of being independent when this is not really the case).

With regulation now imposing professional standards on those who give investment advice, fees and commissions for these services should fairly reflect the value of the service, which is why … it depends. Regulation hasn’t been the only force for change. Standards of reasonableness in financial adviser remuneration have been gradually changing for decades, but without regulation the sort of change that was required would have taken decades more – if ever fully arrived.

Historically the vast majority of so-called ‘investment advisers’ and ‘financial planners’ were little more than salesmen. Worse, really. Unlike insurance agents, whose relationship with product providers was usually out in the open, investment ‘advisers’ tended to disguise the fact that their clients were often the victims of a parasitic relationship between their ‘advisers’ and fund managers.

Sadly, what goes on in many practices still falls well short of a professional standard. Let’s look at a couple of examples.

Case 1
Adviser takes 1.0 percent of portfolio value per year for ‘looking after’ clients’ investments. But the adviser has little if anything to do with the investments. These are in one or more diversified funds, or a master fund. A fund manager or managers look after the portfolio – with total fund costs of 2.5 percent or more per year. In return for their remuneration, the adviser:

Uses a tool provided by a fund manager or an external provider to select a risk profile;
Has occasional client meetings;
Responds to phone and emails from the client, and
Acts as a conduit between client and fund manager – collecting address and bank account changes (and money) for the fund manager, and passing on investment reviews, tax summaries, newsletters and other material to clients – all or most of which is also provided by the fund managers.

Is the adviser’s remuneration reasonable? No (and nor is the fund manager’s – but that’s for another day). Of course we should also consider how well the adviser does the rest of the job: knowing the client, knowing the products – and adding wisdom and skill. It could be, for example, that they persuade a client to stick with a sound investment strategy through a tough period – saving them from a loss that covers their fees for several years.

I call this sort of adviser a ‘fund agent. Perhaps fund agents could charge for one-off value-adds like the one I’ve just described. But any ongoing portfolio linked remuneration should be no more than 0.25 percent per year. And, ironically, this was the pretty much standard rate at which investment ‘trail commissions’ was paid to advisers when I joined the industry in 1990. Now, as one of the worst abuses that persist in New Zealand, trail commission at a crippling 1.0 percent of portfolio value is still common – and for what? Little more than directing client cash to certain funds.

Case 2
Adviser takes 1.5 percent (fees only) of ongoing portfolio value (for the first $100k, scaling down to 0.5 percent for any portion over $1m) per year to provide a comprehensive financial planning service that includes portfolio construction. Services are provided to a relatively small number (under 100) of client households. The adviser takes no commission for investments, and has a lot of involvement with the investments. These are in mix of listed and wholesale securities (saving the client 1 to 2 percent a year in fund costs). Asset allocation targets and an approved list of securities are managed in house, in a disciplined process that involves consultation with a group of experienced peers and robust, external, independent research. In return for their fees, this adviser does all the things listed for Case 1 above, and also:

Provides financial management, insurance, savings, retirement adequacy and income planning, estate and tax advice, referring to and working with external professionals, and integrating all of this as appropriate with the investment advice;
Builds and proactively manages an investment portfolio, taking advantage of opportunities as these arise, and so that the portfolio continues to reflect the ongoing asset allocation and security selection research;
Undertakes accumulation and drawdown planning, relating this to portfolio construction and risk profile considerations, and
Is in frequent touch with clients (aided their relatively small number) explaining and commenting on events and market developments.

Is this adviser’s remuneration reasonable? Almost certainly. While their fees may look high as a percentage of investment value, their services go well beyond these investments. Rather than simply funnelling client money to fund managers, they are advocates for their clients with fund managers.

The days when clients needed advisers to access to markets are gone. The Information Age means anyone with a few clues, some time, and a broadband connection has all the access they need. The old bureaucratic model, with its forms and queues to ration data, has passed. But people still have financial needs and goals. Financial planning may not be rocket science, but it does require judgement, patience and discipline. Today’s clients have less time than ever to do these things for themselves.

A good financial adviser can add real value and command good fees – but investors should make sure that whatever they pay their advisers (and fund managers) they are getting real value in return.

Disclosure: Simon Hassan is a practicing financial planner, a Director and Senior Client Adviser at Hassan & Associates, based in Auckland, New Zealand. His Disclosure Statement is freely available on request and may be downloaded from his website at www.hassan.co.nz.

Posted in Uncategorized | No Comments »

World Financial Planning Summit

February 18th, 2010

This event, a world first, is to be held in Taipei in April 2010. It will coincide with the 11th (I think – there a re two a year) meeting of the FPSB Council. It has a website: http://worldfpsummit.org/, and I understand this summit will definitely not be the last.

FPSB stands for Financial Planning Standards Board (http://www.fpsb.org/), a not for profit that controls the CFP (Certified Financial Planner) marks, sets standards for, and promotes professional financial planning outside the United States. In the US the CFP Board of Standards does the same thing. The two bodies work closely together and are very important to the 126,000 CFP professionals (about half inside and half outside the US) who are permitted to – and proudly – use the marks.

The Summit? A small first step maybe, but another sign that financial planning (that is professional financial planning), whilst still in its infancy or childhood, is not going to stay there - like Peter Pan, addicted to the self deluding ‘make believe’ of children’s – or indeed these days adolescents’ (but that’s another blog) – games.

Financial planning is about helping clients achieve their life goals by helping them manage their finances. Professional financial planning is doing this whilst – transparently and unequivocally placing their interests first. The ‘client first’ rule is still a new one for FPSB, and a mind shift for many. But it is vital for the journey towards adulthood. We all love to laugh and play – and treasure these precious legacies of our childhood – but when it comes to business, adults mean business.

The business of a professional is knowing your stuff (competence), keeping that knowledge up to date, sticking to what you do know, inviting your peers to critique your work (avidly learning from their scrutiny), contributing to the development of others, all while earning a good income. But more than any of these, more than anything else, the business of a true professional is the interests of their client. Above and beyond any other consideration: first, last and always!

I’d love to be there in Taipei – but it’s a long way from Kiwiland. Nonetheless I’ll be there in spirit: willing my global colleagues to accept those frightening and truly difficult challenges, to grin and bear the growing pains, the awkwardness, the self doubt of emergent adulthood, to ‘do what it takes’ to continue the all important journey from its confused and conflicted infancy to the rarefied air of high ground - and well-deserved recognition.

May I live to see the day!

Posted in Professionalism, Uncategorized | No Comments »

Insidious conflicts

November 26th, 2009

It may be a big ask; but there may be no other way for the financial advisory profession to earn the trust it needs. Ban commissions for investment advisers.

For as long as financial advisers accept commissions and other rewards from third parties for (supposedly) meeting the needs of their clients (a Tui ad coming on?) real and perceived conflicts of interest will destroy more trust than can ever be built up by the efforts of good advisers who refuse to be tempted to do the wrong thing.

You may have seen an article I wrote addressing the historical cases and some of the worst effect of this conflict in the weekend press: http://www.stuff.co.nz/sunday-star-times/business/3083791/Heres-some-free-advice-for-the-advisers.

Sure: commissions are not the only source of conflicts of interest for financial advisers. Fee-chargers who pad their hours, employees who oversell to hit their KPIs, and employers who put profits before people – all of these can be just as guilty of setting aside their first responsibility: to care for clients.

And sure: financial advice is not the only conflicted profession. Lawyers and builders can also pad their invoices, dentists and mechanics can do unnecessary work; politicians – even bishops – can allow their focus to move from those they serve to lining their pockets or climbing to power tree. Even doctors get referral fees from specialists, and are constantly wooed by the drug companies.

But in the financial services profession conflicts of interest can be particularly pernicious, and commissions are the largest source of these.

Every profession faces a “knowledge gap” that separates the professional from the client. The professional knows more than their client; otherwise why would they come? This information asymmetry opens opportunities for professionals to abuse the trust placed in them.

But there are added opportunities for financial advisers to give in to self interest. You usually go to see your lawyer, your doctor, your mechanic or your accountant because you have to. Not doing so can have very nasty short-term consequences. And you know pretty soon afterwards if their advice was useful. But it can be decades before the quality of financial advice can be judged – if ever. This means that a good financial adviser also needs persuasive (sales) skills – at various times a financial adviser needs to make clients aware of needs they didn’t know existed, and risks that may never eventuate. So the profession naturally attracts more than its fair share of persuasive types.

Where investments are concerned the opportunities for conflicts escalate. Short-to-medium-term results are often greatly influenced by market conditions. The resulting volatility (up and down) tends to mask the effects of high fees and commissions for a long time – especially when things are on the up. Human nature makes clients and advisers more interested in investments at these (usually wrong) times – and a 10% annual return after costs can look pretty darn good, even is the costs have eaten another 5%. You might think the problem would show up when returns go the other way – but that’s when a persuasive adviser might be able to convince his or her unwitting client that this is all a result of market misfortunes – and that the best strategy will be to stay put.

Which of course it might be, provided that the strategy is a good one, and the costs are not too high…. And how many investors really know what the costs and the risks are in the investment products they use?

All these things multiply opportunities for conflicts of interest to interfere with the objectivity required for truly professional advice.

In the end the only truly effective defence against conflicts of interest is the professional’s personal moral code. So we will never see the end of them.

But surely it’s time the regulator got involved where suppliers and advisers have shown they are not able to make the change. There may be nothing wrong with an tied agent or an execution only broker to accept commissions – it may be the most efficient way for this part of the market to operate.

Ban commission for those who claim to make some or all of their living by advising members of the public about their investments.