The Brave New World Of Financial Advice

Published in Investing on 25 May 2011

Paying commissions will soon be a thing of the past.

Are you getting all excited about the RDR? Are you agog at the prospects for this brave new world of financial advice? What do you mean, you've forgotten what RDR stands for?

If you don't know your RDR from your FDR, here's a quick refresher. RDR is the groovy financial services industry acronym for Retail Distribution Review, and before you die of ennui, here's four words explaining why it could matter to you.

RDR will abolish commission.

So farewell, commission

From January 2013, financial advisers will be banned from charging commission for selling financial products. Instead, they will have to charge their clients a fee.

At a stroke, the Financial Services Authority should do away with the one single factor that has underpinned almost every mis-selling scandal over the last 25 years, as I wrote here last year.

Close the door on your way out

Plenty of financial advisers will rue the day commission died. Some of them I have no sympathy for. They're the ones who made fat profits by mis-selling commission-based personal pension transfers and a host of other under-performing investments, including precipice bonds, with-profits bonds and endowment plans. Many are quitting the industry, now the easy pickings are over.


But I do have sympathy for honest advisers (the large majority). One reason nine out of 10 financial services products were sold on a commission basis is that their clients wouldn't have bought them any other way.

Getting people to pay money into a pension, ISA and insurance plan isn't an easy job, when there are so many more exciting things they can do with their money. Charging them a fee on top makes a tough task even more daunting.

That's why most advisers bundled their fees into the cost of the product. Clients liked it, because they didn't have to write a separate cheque for advice, and could deceive themselves that the adviser got paid through some magical form of osmosis.

Seeing red

Unfortunately, this gave the green light for the financial services industry to try a little deception of their own. Since the industry is more than happy to jump a red, especially if there is a banker at the wheel, this had them revving their engines.

Banks and insurers pumped out investment bonds paying whopping commission of up to 6%, giving advisers a massive incentive to choose them over, say, a vastly superior investment trust that paid zero commission.

A few years ago, my girlfriend was briefly friends with the wife of financial adviser. I remember the woman's glee when she told us how some elderly lady had walked into her husband's shop wanting advice on investing a £200,000 inheritance.

It was 2007, when the average initial investment commission was 5.6%, according to FSA figures. The adviser could have trousered £11,200 for just a few hours work. No wonder his wife was chuffed.

That £11,200 would have come from the little old lady, not the investment company. If she had paid an honest hourly rate, she would have paid just a few hundred pounds.

Initial fleece

Burying adviser fees in the product details caused other distortions. 

Take the initial fee of between 5.25% fee charged by most unit trusts. Some 3% of that is earmarked as commission. The trouble is, you pay it even if you buy direct from fund manager, without any advice at all. The manager simply pockets the fee themselves.

True, you could get round this by purchasing the same fund from a discount broker, but too many investors didn't know this, and paid a high price for a service they never got.

Four out of 10 advisers like it

Those days are now coming to an end -- hooray! -- and according to a new piece of research, plenty of advisers are also happy about that. Just over four out of 10 advisers think the RDR will improve the financial advice given to consumers, according to new research from Skandia. And half of those said the main reason was the ban on commission.

That said, three out of 10 say it will have no effect, and a similar number claim it would have a negative effect. That may be down to the strong resentment many advisers feel towards RDR, which will force them to spend valuable time sitting dreary exams to meet the new standards.

Who will manage the poor's wealth?

Skandia claims the research has abolished the myth that most advisers dread the day that commission dies. I have certainly spoken to many who have embraced the change, rebranding themselves as wealth managers or new model advisers, and cheerfully persuading their clients of the benefits of paying a fee.

They may charge fees in different ways, ranging from a flat hourly rate, to, say, an annual charge of 1% of total funds under management (with initial fund charges rebated). Either way, it will be much more clear and transparent for their customers. 

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Whether customers will welcome that is a different matter -- many will have been happier pretending the advice cost them nothing.

There is one big drawback. As their name suggests, wealth managers will only help the wealthy. You can't offer advice for 1% of funds under management if the client only has, say, £5,000, while a novice investor wanting to buy their first stocks and shares ISA may be reluctant to write their adviser a cheque for several hundred pounds.

The danger is they will nip into their bank instead.

Oh dear.

Retail distribution retirement

Another worry is that adviser numbers will fall sharply, squeezing the availability of advice even further. As many as 10,000 out of 30,000 advisers could quit, according to research from Ernst & Young.

Some of these will be daunted by the new higher level qualifications, others are simply too old to make the change and will take early retirement, and I suppose some just won't be good enough.

I suspect this figure is a little inflated. When they have finished feeling sorry for themselves, most advisers will gradually fall into line. That's how big reforms usually go. Afterwards, everyone will wonder what the fuss was about.

Skandia's research put the number of departing advisers at a measly 6%, that's 1,800 out of 30,000, while only 4% say they have been forced out by the new demands of the RDR.

In fees we trust

I do sympathise with honest IFAs who have been diligently looking after their clients for years and now have to jump through FSA hoops to do pretty much the same job.

I'm just glad there is no such thing as an RJR -- a retail journalist review.

That said, the death of commission should dispel a shadow that has been hanging over the industry for too long. It will also create a more level playing field for investments, with low-charging investment trusts likely to be one of the biggest beneficiaries.

Now that could be something to get excited about.

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MunroMan 25 May 2011 , 12:57pm

Commission will not be banned by the RDR it simply have to be disclosed.

Moreover, most discount brokers still charge commission, but in very opaque ways making it even harder to work out what is the cost of the product and what is the distribution cost.

DIYIncome 25 May 2011 , 5:27pm

If people realise how much the advice is costing them, and how poor the advice often is, perhaps they will make the effort to inform themselves a bit better - and the Motley Fool is an excellent starting place - and do a bit more DIY investing. Perhaps the MF could start a 'newbie' DIY briefing section?

curedum 26 May 2011 , 10:44am

Abolishing commissions is to be welcomed, but I am concerned about small investors who can't afford the up-front fees. If IFAs have to do a full "fact find" lasting a couple of hours, even for a small ISA, how can this be economic?

I fear that we may see a two-tier system, with wealthier clients getting good advice but poorer people getting little or no help.

backdated 26 May 2011 , 1:51pm

You'll be amazed; a lot of so-called qualified financial advisers have nothing to offer on an invoiced fee basis (except total ignorance of matters financial) and consequently will be looking for other work or retiring.

They're mostly so thick they don't know the difference between a(n often questionable) sales process and actually offering fully-considered independent financial advice.

The reason changes weren't made to Regulation years ago is that a lot of folk at the FSA (and its many predecessors) came from the insurance sales industry themselves.

This change of culture is long overdue.

brownsfriend 26 May 2011 , 2:33pm

The small investor was previously subsidised by the large. Perhaps this was unfair or maybe a positive social outcome. The small investor will quite simply have nowhere to go and financial ignorance will continue.Journalists can rant all they like but many financial products have to be explained and sold for the good of the recipient. The RDR will exclude the masses who will remain underinsured,underpensioned and with no worthwhile long term savings.

Investment trusts are a great investment format but unfortunately were considered to be shares by FSA and its predecessors and were not permitted to be advised by an IFA. With your low opinion on the ability of some IFAs it was probably a good job as stockbrokers made a complete hash of it with the split level trust debacle. Unit trusts have broadly the same charging structure than the much derided investment bonds.Bonds could give a mix of asset classes under one roof which many unsophisticated investor really liked, together with the option to take a fixed monthly'income' by withdrawal. It was a case of horses for courses. I was an IFA for 20 years and retired due to illness in 2003. I tried many times to persuade clients to pay fees rather than commission - the problem was that fees mean paying upfront for the work done even if the advice is not taken up. Commission is however, only recieved if the advice is taken up.Quite understandably why pay for something when you dont know what your going to get - its like employing an estate agent to sell your house and paying them a fee for marketing your property even if they dont sell it. Even though it may cost more overall most folk would rather pay a larger fee for success not a promise.
The RDR will at a stroke help the wealthy and abandon the poor.

backdated 26 May 2011 , 5:15pm


I'm sorry, but you're close to proving my point.

Straight into sales processes with preconceived, prepackaged outcomes. Straight into high-commission subject matter (and a defence of it); no mention of objectivity - no promise of considering unique individual circumstances and producing unique solutions.

"Fact Finds" don't take long if you're actually interested in them - if you know what you're doing - and simple straightforward advice doesn't have to be expensive.

The trouble for decades has been that - in too many cases - everybody ended-up with the same pre-packaged "advice", irrespective of "Facts Found".

And I was a Tax Consultant/ IFA (in what I would like to think was a professional Firm) for somewhat longer than yourself. Having trained also in Banking, Accountancy and Insurance, perhaps I acquired a more critical "warts and all" view of the whole industry than others (and I honestly don't recall "the poor" requiring the services of an IFA).

timthegambler 27 May 2011 , 1:10pm

Why go to an IFA? Put savings for short-term in low-risk assets, and money for long-term savings in trackers in ISAs.

Work our what your liabilities and dependencies are, and take out insurance for them.

Put money in a pension as early as possible

Don't get in debt (except mortgage) and follow an approach based on how comfortable you are with risk.

Then go enjoy life.

RobinnBanks 30 May 2011 , 4:41pm

IFAs are for people who can't be bothered to educate themselves about finance, or have that much money they don't care what the charges are as long as they don't have to manage their investments.
Motley Fools and other dedicated investors spend years learning their craft and would never pay for often poor advice.

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