When we set out the way we wanted to do business at Altor we looked at the current structure of financial advice and investment management to see if there were gnarly old dragons that needed slaying. We think we found a few but the focus for today is on the old fashioned model of charging a percentage for advice and investment management.
I am a passionate believer that an adviser taking a percentage of your capital for advice will always introduce conflicts of interest and often lead to the wrong outcomes. If the only way the adviser is going to be paid is if they pursuade you to invest, then why would they advise you to pay off debt, buy property, add to your company pension scheme and indeed very topically at the moment why would they recommend that you stay in that gold plated final salary pension scheme and not transfer to a personal pension? At best the very good advisers out there (and there are plenty) who take a % charge will feel conflicted and under pressure, sucumbing to small temptations to swindle you whilst telling themselves that it is okay because they are avoiding the big temptations.
The problems with % fees don’t stop there of course. Alan Smith, who runs Capital Asset Management in London and very bravely made the switch from % fees to fixed £ fees a while ago, puts it much better than me when he describes the problem of the ‘four Cs’: cross-subsidy, conflict of interest, contingent charging and cost. You can read his article here: Alan Smith article.
Financial services must be one of the last industrys that thinks it is still okay to charge in this way, with the not very honourable exception of estate agents. Advisers want to be regarded as trusted professional but haven’t made the change to bring their charging in line with solicitors, accountants, surveyors, architects (the one large building project I have worked on that involved the architect taking a % of the build cost went hugely over budget). Paul Lewis, former Altor Money Hero of the Month, recently wrote very well on the perception problem this is giving the profession here: Paul Lewis article.
Charging a fixed fee though is still a minority sport and we only know of a couple of handfuls of firms who charge a fixed monthly fee like Altor to maintain complete independence from the process of advice. So why is this? Well the likely answer rests with what economists and psychologists have found about how human beings process numbers. Most of us have a form of money blindness which means that we don’t process large numbers as well as we do small numbers and we don’t process a percentage as well as we do a pounds and pence figure. In this way we might grumble about the cost of a train ticket but happily hand over £30k for the new car or the way we have to convince ourselves that our main residence is an ‘investment’ otherwise we wouldn’t justify paying so much. I have seen it in action in my previous job where some clients were paying high five figure sums in charges that they never would have agreed to if someone had asked them to pay the £ figure rather than the % figure. 1% of your capital doesn’t sound like a lot to pay but £20,000 all of a sudden does, at a very fundamental level our brain has processed the number 1 and said ‘that is a small number’ and the number 20,000 and said ‘ that is a big number’ but for the £2M client it is the same number.
Where this model of charging can get really pernicious is when the adviser is taking a large part of the future growth from a client. In a possible future world of low average investment returns and low inflation the adviser might be taking half of the clients growth away from them. A family friend recently approached me for some free advice about his small pension pot. His IFA wanted to charge him 2.1% per annum (all in), now if inflation is 2% and he as a low risk client is only likely to gross 4%, or 2% above inflation, the IFA is making as much from this pension as the person themselves are making. This is highly detrimental to someone who will be going into drawdown within five years with not enough in his pension as it is. Malcolm Small writes well on the issues with percentage fees for drawdown clients here: Malcolm Small article.
There is a few voices in the profession calling for a change as above and here; Alistair Whitehead article but the most interesting thing is not the call but the backlash. It is worth going back through the links in this blog and reading the ‘below the line’ comments, there you will see some of the most self-centred and illogical counter arguments you are likely to see on any subject. These articles seem to generate the most negative comments from the profession, which I take as a sign that things do need to change and will change in time.
Finally this is not an issue just for the advisers, as a firm we still have to use platforms that charge a % (Alliance Trust deserve an honourable mention here as one of the ones that charges a fixed fee) and fund managers that charge a %. We will return to the subject of the wider industry and fixed fees at a later date.