How much is advice really costing you?

Do you have a financial adviser, and if so are you getting a fair deal? Fin24 user Jonty Heathcote gives some guidelines. He writes:

When it comes to investment products, there are a number of different fees you may pay. Typically these fees can be divided into three categories: administration fees, asset management fees (including performance fees) and advice fees. 

Given the scope of the topic, this article will focus on advice fees.

For many of us, using the services of a financial adviser is a necessity. They can make sense of the complex world of financial services, have the tools and skills to guide us in the right direction and the ability to match the correct products to your specific needs. 

It is reasonable that advisers get paid a fair fee for these services.

However, when it comes to commission, the rules of the game, as well as information asymmetry – meaning financial advisers typically have more information than you do when making decisions regarding your money – can lead to situations where you are not paying a fair value for financial advice. 

Many of us are never aware that this is happening.

This is particularly true when it comes to commission (or advice fees) on investment-related products.  Currently, the legislation in South Africa allows broadly for two types of commission and normally you will be paying either one or both of these fees. 

Most of us will be aware that we are paying commission of some sort, but won’t necessarily understand how much commission is actually being paid.

The first type is a premium-, or contribution based commission. In this case, a percentage of each and every contribution you make is paid to your financial adviser. Typically, this commission is levied to a maximum of either 3% or 5% of your contributions, depending on the investment product. 

Some of this commission may be discounted over the expected term of the investment product, which means that it is paid upfront to your adviser.  

The second type is a fund-based commission – sometimes referred to as an “annual advice fee” or “trail fee”. Rather than a percentage of your premium being paid to your financial adviser, a percentage of your total accumulated fund is paid to your adviser every month. 

The maximum amount of this commission is typically 1% of your fund, levied annually. But as with all types of commission, this is negotiable.

It is clearly not easy to compare these two types of commission to decide what might amount to a fair deal. Although 1% sounds lower than 3%, over the long term a 1% fund-based commission may become significantly more expensive than a 3% premium-based commission levied on the same investment.  

When comparing the relative size of commissions, the most important factor is actually the length of time you are planning to invest for. With a regular investment contribution, you are likely to pay more premium-based than fund-based commission if the investment term is shorter than 10 years.  

For example, over 5 years, with a R1 000 regular monthly contribution earning a return of 10% p.a., a 3% premium based commission would lower your eventual fund value by approximately R2 300 while a 1% fund based commission would lower your fund value by approximately R1 900.  In this example, a 3% premium based commission would cost you almost 20% more than a 1% fund based commission would.

The story changes dramatically when your investment term is 10 years or longer.  The table below summarises the reduction in your eventual fund value as a result of the various commissions, for a R1 000 regular monthly savings contribution.

As you can see, with long term investments the “smaller” 1% p.a. fund based commission has a significantly bigger impact on your eventual investment fund value than the “bigger” 3% premium based commission.

In the case of the investment we’ve used as an example in this article, the impact of a 1% p.a. fund based commission over 25 years is best displayed graphically.  Without any commission, your fund would amount to R1 243 160 after 25 years, but R177 852 is sacrificed as a result of the commission.

 

Advocates of the fund based commission will argue that they are being paid this commission to provide on-going investment advice. This argument can have some merit if, in fact, you are receiving on-going investment advice. 
If, on the other hand, you haven’t seen or heard from your financial adviser since the day they sold you the investment product, then you are fully within your rights to contact the product provider directly and ask them to remove the fund based commission.

Another thing to bear in mind is that a fund based fee, when expressed in rand terms, will increase exponentially as a fund grows over time.  You also have the right to re-negotiate this fee at any stage, and are by no means locked into a commission arrangement for the duration of your investment term. 
As your investment portfolio gets bigger and bigger, you shouldn’t have to pay more and more commission for the same service.  Don’t feel ashamed to renegotiate this fee downwards as your investments grow. 

In general, it’s best to let the facts and figures lead you when negotiating commission.  The best commission is the cheapest that gives you access to good financial advice.

The FutureGuide Investment Cost Calculator will give you a good idea of the impact that fees can have on your investment.

- Fin24

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