Advice at a price - the cost of commissions

NOT paying fees up-front doesn't mean you're getting free financial advice. Commissions cost Australians hundreds of millions a year.

Coins

Advice at a price - the cost of commissions

ARE you being tricked by a money illusion? According to the Reserve Bank of Australia, yes, many of us are, but we are willing players.

At some stage during our lives, mostly as retirement approaches, almost everyone will seek financial advice. Now the debate about how that advice is delivered and paid for is becoming white hot.

Whether it is as simple as consolidating our superannuation accounts or as difficult as maximising Centrelink entitlements and keeping some investment assets, advice from a planner, accountant, super fund or bank is becoming essential.

The "illusion'' is how we pay for that advice.

Mostly, financial advice is paid for by sales commissions and trailing commissions from the fund managers and financial products that the adviser recommends.

That creates an obvious conflict of interest because there is an incentive for the adviser to recommend products or super funds that pay commissions, whether or not they are the best option for the client or not.

The advice looks free but isn't. In fact it is costing some Austalians big time.

In the year to June 2007, more than $2 billion was taken from the super accounts of ordinary people to pay sales and trailing commissions to financial planners and advisers.

According to research for Industry Funds Network undertaken by Rainmaker, $765 million of commission money came out of the compulsory super payments made by employers.

"The payment of sales commissions to financial advisers out of compulsory contributions seems morally wrong and detrimental to retirement savings of many Australians,'' said Industry Super Network spokesman David Whiteley.

"Commissions are levied for ongoing financial advice but the value of such advice is unclear.

"This is an area requiring further investigation but it does appear that many employees are not even aware that they are paying commissions out of their compulsory contributions.''

Sales or advice?

The Financial Planning Association debated this issue at its last annual conference in a session called: "Are we professionals or product floggers?''

Superannuation funds also recently debated sales commissions at their conference, in a session that included accusations of systemic illegal conduct by large financial institutions.

Generally, the tide seems to be turning against planners and advisers who work on commission.

The companies regulator, the Australian Securities and Investments Commission, has criticised the practice and even the Reserve Bank has made strong remarks against commission payments to advisers.

"There appears to be a general reluctance on the part of retail investors to pay for financial advice on a fee-for-service basis,'' the deputy governor of the Reserve Bank Ric Battellino said recently.

"Instead, there has been a preference for commission-based advice, despite the conflicts of interest that can arise in this situation.

"This reluctance to pay for advice upfront appears to be a form of money illusion, whereby investors may feel that they are somehow paying less for financial advice if the cost is buried in reduced earnings in the future,'' he said.

ASIC also loaded criticism on the payment of commissions in its landmark 2006 report.

ASIC found that superannuation advice provided by financial planners earning a commission was six times more likely to be "bad advice''.

In 2007, ASIC forced AMP to undertake that its planners would disclose to clients their sales commissions.

Legally, there is a requirement for advisers to give clients a written statement that sets out, among other things, any potential conflicts of interest and the dollar value of commissions they stand to receive.

But that is not enough, according to some industry observers.

Although there is supposed to be full disclosure of commissions and trails, in most cases people don't understand the true financial impact.

Trailing commissions

Merv Gay is a financial planner who has been working in the advice industry for 37 years. He remembers when there were no trailing commissions.

"They were introduced 20-odd years ago as an incentive to continually look after clients,'' he said.

"Previously one commission payment only was made for a sale, consequently some agents just looked to make a sale and run away.

"The introduction of trailing commissions meant agents could build a business and maintain a growing relationship with a client and be paid for the service they give,'' Mr Gay said.

However, all members of the fund are paying additional fees to cover those trails, whether they get individual advice or not.

According to ASIC, 20 per cent of people who are advised about which super fund to chose have probably or definitely received advice that does not comply with the law.

Mr Gay says trailing commissions help people who aren't wealthy access good advice from professional planners.

"A small trailing commission is essential to pay an adviser for his work,'' he said.

"Not everyone can afford to pay $300 an hour for an adviser to collect and amalgamate half a dozen small super accounts which are scattered far and wide, then prepare a report, then spend a few hours discussing with the client the best course of action.''

"Rubbish'', said David Haynes, general manager of Industry Fund Services, which runs Industry Fund Financial Planning.

"Many institutions actively screen out people with low net worth from coming face to face with a planner. And people who do sign up for advice with a trailing commission do not generally get ongoing service or advice from the planner,'' Mr Haynes said.

Others also disagree with the benefits of trailing commissions.

"`A fee for service approach is better in the long run for the relationship between customer and planner,'' NAB Financial Planning general manager Geoff Rogers said.

"Customers prefer it and planners in our business who work this way have long-term relationships with their clients as a result of it.''

However, most financial planners seem adamant that the commission model is ethical and essential.

"Mark my words,'' Mr Gay  "take away trailing commission and you throw small clients to the wolves.