If you’re spending good money on a financial advisor, you will want to make sure the advice they give is genuinely independent, rather than potentially influenced by a degree of self-interest. How do you go about doing that in practice?
What’s an IFA?
The term Financial Advisor includes three categories of people. There are ‘tied’ advisors, who work for a particular institution such as a bank or insurer, and offer only financial products provided by that company. There are ‘multi-tied’ advisors, who offer a broader range of products, but are still limited to certain companies. Then there are independent financial advisors (IFAs) who are not tied to anyone and can therefore offer whole-of-market advice.
The advantages of this are obvious: with more products on offer, an IFA is better placed to find the one that will best suit you. But crucially, this independence also removes an element of self-interest, because the financial advisor is not necessarily paid by the owner of the financial product he or she recommends. The option to charge by fee rather than commission is one of the defining characteristics of an IFA, and the reason they can be considered properly independent.
Financial advisors broadly make their money in two ways. They may be paid directly by their client – the person who approaches them for financial advice. But they may also be paid by the institution whose products they sell. (Some financial advisors take a combination of fee and commission for their advice.) Most big financial organisations, including pension providers and insurance companies, offer a commission or ‘kick back’ to the salesperson. This often involves an initial payment and a ‘trail fee’ which continues for the lifetime of the customer’s purchase of the product. This makes sense for both provider and advisor, since the customer’s investment could represent a significant amount of money over the lifetime of the product – which could be several decades. If they can encourage that investment by incentivising financial advisors to recommend their products, so much would be better for them.
This state of affairs is not always best for the client. Although financial advisors have an obligation to provide the best information for their clients at the time of consultation, the practice of being paid by commission from financial institutions raises questions about the impartiality of their advice. This is why IFAs are required to offer the option of fee-only advice: it removes any question that their advice is being influenced by the size of the commission they will receive from the provider.
The nature of the fee should be something you discuss with your financial advisor in the first meeting. In most cases, this will be a ‘fact finding’ exercise in which you talk through your needs with the IFA and various options are suggested. This will usually take place without any charge. If you subsequently decide to take the advice offered, you will need to pay the quoted fee, or opt to pay by commission (which may affect the value of any investments over time, since it can come out of your regular payments). Many financial products can only be organised through the services of an IFA, which means you cannot simply take the free advice and arrange them directly yourself.
Above all, you should expect transparency from your financial advisor. Their job is to give you the best possible advice on matters of investments, pensions, insurance, tax, inheritance planning, and so on. You should receive illustrations and projections of your chosen financial products, as well as clear explanations for why these products have been chosen. There should be no reason to doubt their impartiality, which is why the elimination of potential self-interest by charging a fee rather than commission can bring peace of mind. In other words, an independent financial advisor works for you – not for a big financial institution.