Good financial advice hard to get

[Musicwhiz]

The Straits Times
Apr 8, 2012
Small change
Good financial advice hard to get
Watch out for advisers who put commissions above clients' interests

By Andy Mukherjee

If you think used-car dealers are the ultimate in pushy salesmanship, with glib-talking agents trying to pass off expensive pieces of junk, try getting some financial advice.

A second-hand car may have a few problems with the braking system, and a wily salesperson may just omit to mention them. But it's unlikely you'll go home in a vehicle without brakes.

Finance is different. Products that have been designed with the explicit intention of sending you skidding towards an unpleasant crash are a dime a dozen. Your financial adviser's job is to protect you from getting in harm's way.

If the adviser sees such toxic material in your portfolio when you meet him the first time, he must reason with you and get you to reconsider the risk that you may not even be fully aware of.

Instead, if the adviser takes a look at your portfolio and says to himself, 'This idiot will buy anything I can sell him', then we have the start of a beautiful friendship that will terminate with the adviser sipping white rum on a sandy beach while you file for bankruptcy.

The Monetary Authority of Singapore (MAS) said recently that it would subject the financial advisory industry to a review. The idea is to lower costs for customers and improve the quality of advice. Ask yourself: Why does the MAS have to force the industry to raise its game? Why can't market forces reward good advisers and force out the bad ones?

Well, that's because the market for financial advice does not self-correct.

Since advisers continue to be a part of the supply chain that makes and distributes financial products, their remuneration is from commissions. How does an adviser maximise commissions? By increasing volumes. Advisers who genuinely care about their clients' interests will not nudge them away from low-commission products.

They will also not force them to start chasing every hot trend - regardless of their clients' risk appetite - or churn their portfolio more often than is necessary. As a result, good advisers will earn less commission and be more likely to leave the industry. Hustlers, meanwhile, will thrive.

This is not a problem restricted to Singapore.

Last month, Professor Sendhil Mullainathan, a prominent Harvard University behavioural economist, published a study he conducted with two other researchers on the financial advice industry in the United States.

The study followed a novel approach. Trained auditors were assigned fictitious careers and portfolios and sent to real-life financial advisers. The advice they received was recorded and analysed.

The researchers' conclusion? 'Advisers encourage returns-chasing behaviour and push for actively managed funds that have higher fees, even if the client starts with a well-diversified, low-fee portfolio,' the study notes.

It adds that, in some cases, advisers even push clients towards funds that charge higher fees with little added benefit from portfolio diversification. In short, expected returns for clients will be lower.

This damning indictment of the industry gets more interesting. It appears that, despite delivering inferior advice, the industry is doing a fine job selling its wares to an unsuspecting public. Auditors said they were willing to go back to 70 per cent of the advisers they had visited - now with their own money.

The researchers did not test if changing the incentive structure would change the quality of advice. For instance, instead of sales commissions, what if an adviser made a living purely from fees generated from clients? In the Singapore context, these advisers are the only ones that are allowed to call themselves 'independent'.

If all advisers were purely independent, would the quality of advice get better? Or will the fees become so high that small investors will get priced out and return to the same commission-earning adviser who gives them bad advice now? We don't know the answer but it's worth finding out.

The industry in Singapore is a little jittery about what kind of changes the MAS will thrust upon it, and whether the pace of adjustments required of it will be so rapid as to cause a major shake-up.

Key changes should be gradual to ensure that the financial advisory industry 'will not be severely or negatively impacted', as the Association of Financial Advisers said in a March28 statement.

andym@sph.com.sg

[d.o.g.]

This damning indictment of the industry gets more interesting. It appears that, despite delivering inferior advice, the industry is doing a fine job selling its wares to an unsuspecting public. Auditors said they were willing to go back to 70 per cent of the advisers they had visited - now with their own money.

While the advisors are a big part of the problem, part of the blame also lies with clients.

If clients demand better service AND are willing to pay for it, they can get it. As an extreme example, a private banking account costs the client a lot more to maintain than a regular savings account, but private banks continue to prosper.

As was noted, there ARE advisors out there who are fee-only. But the reality is that they are few and far between. Why? Because many clients do not want to learn enough about their own finances to realize how little they know, and thus how vulnerable they are to exploitation.

These are not illiterate grannies buying a magic stone. These are often otherwise-successful people who do not wish to allocate time to understand the limits of what an advisor can do. As a result, they give the advisor too much leeway.

Few advisors will knowingly sell harmful products; after all they don't want to kill the golden goose. But given the difficulty of differentiating among the multitude of products available, if 2 products appear similar enough, logically the advisor will sell the one with the higher commission. Same selling effort, more money. Easy choice.

As for the apparently-high fees charged by fee-only advisors, part of it is competition. If there is more demand, there will be more supply, and that will in turn help bring fees down.

Many small investors have relatively simple finances e.g. the financial assets might comprise a savings account, a house, and maybe a few unit trusts. Financial liabilities might include the mortgage, a car, and feeding/schooling for the kids. Goals might be money to bring up the kids if one parent dies, annual holidays and a decent quality of life at retirement. This kind of analysis is fairly standard and wouldn't cost $3k. But someone who has houses in 3 countries, has kids from another marriage, and is trying to wall off assets from future creditors, has to expect to pay up for lawyers, and $30k might not be enough.

In finance it is especially true that "if you think education is expensive, try ignorance!"

As usual, YMMV.