Unpacking payments for investment advice
It's either commission or fees - and both structures have their pros and cons
Consumers seem to have wised up: fewer complaints are being made to the financial advice ombudsman and the pension funds adjudicator about the sale of high-risk investments to the vulnerable - such as widows and pensioners - by financial advisers motivated by exorbitant commissions.
But with the threat of regulations that will cut their commission income, advisers are finding new ways of charging for their guidance.
So, for example, many are charging fees based on the value of your investments under their advice - which still presents some conflict when it comes to getting the best counsel. If your adviser is willing, you may want to negotiate a fairer fee structure.
These are the fee structures in use and what you should know about each of them:
Commission is calculated as a percentage of the amount you commit to investing or paying towards an investment or policy.
Commission is paid to your adviser by the financial product provider, so although it appears as if the advice you get is free, it is actually recouped in your premium or contribution. The commission in rands should be disclosed to you.
Most financial advisers earn their money from commissions, particularly for life assurance policies against death, disability and severe illness.
Advisers are also paid commission on investments sold, particularly by tied agents who work for a financial services company.
The temptation is for advisers or brokers to sell you a certain financial product just so they can get paid a commission.
It may be that the best advice for you would be to reduce your debt rather than invest, but you may not be given that guidance by someone who relies entirely on being paid commission.
Commission also incentivises advisers to get you to invest or buy cover for as much as you can afford, because they will earn a higher commission. The way commissions have been structured by life assurers has encouraged advisers to make their clients invest in financial products such as retirement annuities and endowments for a very long time. The minimum term for these sorts of investments is five years.
As a result of these long terms, many investors have incurred severe penalties for stopping payment or reducing their premiums on life company retirement annuities or endowment policies before they mature.
In 2014, the financial services regulator, the Financial Services Board, issued a draft policy document, the retail distribution review, proposing different ways of regulating the distribution of financial products and how advisers were to be paid.
The board proposed banning commission on investments, forcing advisers to charge you a fee for investment advice.
It also proposed reducing the upfront commission paid on risk policies to 50% of the commission due - the rest of the commission would become due when you pay your premiums. The board expects to implement the proposals from next year.
Fees on investments managed
Those advisers who have abandoned commissions in favour of fees have mostly asked for payment calculated as a percentage of the value of what you have invested on their advice. The industry refers to this as "the assets under management fee".
Brian Foster, a co-founder of Beyond RDR, a consultancy that assists financial advisers, said most South African consultants charged 0.5% of the value of your investments.
The fees are deducted from your investments by the investment house and paid to your adviser.
One of the main sticking points is that the fee is often not commensurate with the amount of work the adviser has to do for you.
If you have only R1-million invested, your adviser will earn R5 000 a year, and R50 000 a year on R10-million. Investing R10-million is likely to be more complicated and will probably require more work by the adviser, but there isn't always a match between fees and the advice required.
At a recent seminar for members of the Financial Planning Institute of Southern Africa, lawyer Almo Lubowski said fees based on the value of your investments could poison your relationship with your adviser.
As long as your investments are earning good returns, you may be prepared to accept such a fee. But in difficult times, when returns are low, the investor may wonder why such a large proportion of their earnings is being paid to the adviser.
Lubowski said advisers had no control over investment markets - so should not earn fees based on what the markets delivered. And advisers who charge a fee based on the value of the investment will have little incentive to take you on as a client if you are just starting to build an investment portfolio.
Foster saidthe adviser who charged in this way was incentivised to merely get your existing investments under their advice.
Some advisers who charge a fee based on assets under management also demand an initial payment for a financial plan - anything from R5 000 to R40 000.
Those who did not charge an initial fee, said Foster, had to do a lot of work to establish your circumstances and devise a suitable financial plan for you before earning anything. This might compromise the quality of the plan produced for you.
Other ways in which advisers structure their fees:
Few South African advisers charge a fee based on a predetermined hourly rate for their advice. Those who do so may collect the money from any commission paid on any policy or investment, or they will send you a bill.
Certified financial planner Almo Lubowski said the problem with time-based fees was that you had no idea how many hours of guidance you would need or how many hours of research and behind-the-scenes work your adviser would require.
Again, this was unusual in South Africa, said Brian Foster, a co-founder of Beyond RDR. Advisers who do will have a menu of activities, for example, drawing up a full financial plan, planning your estate or drafting a will, with a set fee for each activity.
Another rare bird: you would regularly pay an agreed amount to your adviser to cover all fees, regardless of the time those tasks take to complete and how many tasks there are.