“Clearing up a misconception”
Now that we are only weeks away from the implementation of the RDR on 1st January 2013 and we enter the Fee Only Financial Advice Era it may be appropriate to clear a misconception: I find the idea that a financial adviser’s turnover equals profit a strange notion, but it was one that was put to me by intelligent clients only a few weeks ago.
The clients said that because the typical adviser turnover was £100,000 per annum then we were “rolling in it”. I was taken aback and have given it some thought since. After all if they held this misconception perhaps other clients thought the same way too. I thought that the idea was strange because they understood that if your local store or garage has a similar turnover it is not expected that this is profit and yet they didn’t apply this same understanding to the business of financial advice. We know that there are differing profit levels for different types of business and for the typical convenience store the profit level may be about 5% of turnover, whereas other businesses may achieve profit levels of 50%. Whatever the profit level it is accepted that turnover does not equal profit. I haven’t yet fully researched figures for financial advisory businesses, but I know from several business sources that many operate at less than 10% profit from turnover with the best achieving about 30% profit.
So let’s look at a typical £100,000 turnover, where does the money go? I may give a more detailed report in a newsletter in the New Year but from experience I know that 20% goes in Regulatory fees: to The FSA, FOS, FCCS, and Professional Indemnity Insurance; another 20% is taken with software and office charges; a further 20% goes to support staff and research; while yet another 20% is taken up in seminar charges, exam fees, travel cost, and so on. This leaves 20% or £20,000 left to pay the adviser and this can soon be eaten away by other costs, so it may surprise you to find that many financial advisers have operated on an annual income of £15,000 – which can hardly be described as “rolling in it”. The FSA have been aware of this and one of their expectations is that each business and indeed each client within that business should be profitable. The FSA have also expressed their dislike for ‘cross-subsidy’ where one client pays more and subsidises another – they expect each client to pay the same for similar services.
My client suggested that taking 3% of an investment of £100,000, or £3000, was too much and that my fee should be 1.5%, or £1500. What was not understood was the level of fixed fees will be the same regardless of the level of fee taken. If we apply my percentages from above £600 goes to regulatory fees, £600 goes to software and office charges, £600 goes to support, and without going any further the total so far of £1800 means that the client’s business would already be at a loss with no remuneration. And of course no one wants to work for nothing.
And back to the RDR and 2013: – There will be a few thousand advisers that will struggle who up to now have taken up to 7% commission or more on investments and who have not streamlined their businesses to make them run as efficiently as possible. This is one reason why it is widely reported that clients with moderate assets (say less than £250,000 to invest) will be disenfranchised by the RDR and will be unable to obtain professional financial advice. If those advisers are unable to take a 7% fee then their way forward is to take 3% from higher level investments and anyone with £100,000 to invest will not pay them sufficiently for them to make an income.
I remember being in a conversation with the FSA 3 or 4 years ago when I said that an adviser could help clients who had only moderate assets by developing systems and adopting efficient processes so that their business could be processed quickly. In the same conversation I also said that the concept of an hourly rate was fundamentally flawed because why would anyone want to become more efficient so that a job could be done quicker when on an hourly rate basis it was going to result in a lower fee. Why would they want to be more efficient and use the efficiencies of software and systems if they were going to charge for fewer hours? I have been successful over the last few years in making my systems as efficient as possible which is demonstrated by my ISO 22222 certification with the BS8577 being added next month. I believe that all clients should have access to high quality professional advice regardless of invested assets and that is only sustainable by running efficient processes and charging at a realistic level for the work done.
I have been 100% behind the Retail Distribution Review from the start. The transparency of the adviser fee and all other charges is a wonderful achievement. However now is the time to guard against looking for price instead of looking for value. I remember as a child when my parents bought me a bike – typically they always went for value and considered the price only as a secondary factor. My friend’s parents always went for price and when my friend got his third bike in two years because his first two bikes had broken beyond repair and my bike was as good as new (well almost) I started to understand. By the third bike they had spent in total double what my parents had spent and I learned a good lesson. Price may be important but put value first and not second.
Ric Edelman’s “Rescue Your Money”
For the last few months I have been reviewing Ric Edelman’s “Rescue Your Money” and I want to start by quoting Ric:
“Investors buy when stocks are rising and sell when stocks are falling”
Yes this is crazy but in the last 23 years of advising I have seen this too many times for it to be taken anything but very seriously indeed.
Ric’s has great insights on the fallacy of market timing; the avoidance of following fashion; and why you shouldn’t trust the media. In fact this month we are going to look at how not to invest and you will have to wait until the next newsletters to find out what you should do.
Following the Fads: This is not new: From the Dutch Tulip Craze of 1636, The South Sea Bubble of 1720, though to the ‘Dot.com’ Bubble of 2000, to the Property obsession of 2000 to 2005, all fads dramatically and tragically demonstrate how not to invest. People buy into fads after the prices have already risen simply because that is when they hear about them. It’s another example of buying high and selling low. Ric follows up with a great piece of tongue in cheek wisdom:
“If you want to successfully invest in a fad, all you have to do is buy it before you’ve ever heard of it”.
Do you Trust the Media? Ric lists so many examples of how bad the Media are as a source of advice it is too painful to repeat. He sums up with: –
“Trusting the media’s investment advice is not a successful strategy. Yet judging from the millions of people who read, listen, and watch all the commentaries, it’s also clear that most people don’t know this.”
Not-So-Expert Advice: The problem with trying to follow the experts is that they never agree. Every year there is certain to be someone who predicted correctly but the problem is it’s almost never the same person twice. Sometimes people get it right. Sometimes they get it wrong.
“Predictions are not reliable in sports, nor about the weather, nor on Wall Street.”
So don’t rely on experts.
Don’t Count on Quality: Many investors simply default to the oldest, biggest, best known, and most popular companies. Yet time and time again history shows us that investing in large, well established companies does not mean that you are immune from suffering massive losses over extended periods of time. One of the biggest common mistakes is that employees invest in their own companies. When their company goes to the wall so do their investments.
Hot Sectors That Aren’t: Instead of investing in specific stocks or a specific industry some investors choose a ‘sector’ and choose ‘large companies’, ‘small companies’, ‘UK Stocks’ ‘Growth Stocks’, ‘Value Stocks’ and so on. In any given year one beats the other however the evidence shows that it is impossible to predict which one will do better than the other the following year. Yet many investors insist on trying!
So now that Ric has told us how not to invest what next? Ric reveals “The Secret” to show us how we can invest and get a reliable return but before he does he dispels two myths which block many people’s willingness to enjoy that return. That’s what I will be looking at next month. In the meantime if you have any queries please get in touch.
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