With emphasis from the Financial Services Authority now on financial advisers to provide more transparent charging options, clients will find it likely that one of their first decisions when taking advice is whether to pay for that service by fee, or allow the adviser to receive commission from the product provider. Choosing from the selected adviser’s payment options in advance of advice will be a new process for many and it is important to understand how this decision could shape the eventual recommendation.
First things first, potential clients should understand that commission does not mean that advice is free. Although the advantage of commission is that the client will not be required to make an initial outlay to the adviser, the underlying product charges include deductions to pay the adviser commission instead. Therefore in a basic example, an investment of £10,000 could include an initial charge which pays the adviser commission of 4% of the investment, meaning that only £9,600 is invested and £400 is deducted and paid to the adviser as commission. The commission is therefore paid by the client indirectly.
A potential limitation of commission would be that it could influence advisers into recommending products that pay high levels of commission rather than the merits of the investment, as some products can pay commission as high as 8%. Although not as widespread as is commonly suggested, it can happen and it is also likely that an adviser receiving commission is unlikely to recommend a product that pays little or no commission at all, such as an index tracking fund. Would you work for free?
The alternative option is to pay an agreed fee directly to the adviser and to have all commission rebated either to the client or back into the investment to lower or negate the initial product charge. In our example above the 4% commission could be rebated to the investment to offset the initial charge meaning that the full £10,000 is invested for the client and a fee paid directly to the adviser on an agreed fixed basis, a percentage of the investment or an hourly rate. Be careful though because fees can be an expensive option when applied to smaller transactions and some firms charge more than others. In general though, the advantages of paying by fee are:
1. The client knows and agrees in advance exactly what the adviser is to be paid.
2. The fee cannot influence the advice as the adviser will be paid the same amount regardless
3. The larger the investment the more likely the adviser is to offer a fee option that is more cost effective than the commission option.
4. Lower cost and nil commission paying products such as index trackers are more likely to be considered.
So when you next seek financial advice consider whether paying by fee may not only be more cost effective but also ensures the advisers impartiality. You may not be used to paying a cheque directly to the adviser but you can be certain that in the past you have paid much higher amounts indirectly through product charges and commission.
Alexandre Riley is Director, Medical & General Independent Financial Advisers.
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