Friday, 28 June 2013

Thought for the week – which is better for the client a fixed fee or a percentage fee?

I recently came across a blog where a financial planner disclosed they received 3.5% up front for single premium investments. They were less committal on their on-going fee but I suspect this was in region of 1% a year.

I also read an interesting piece claiming that a percentage fee was fairer for the client than a fixed fee based on the amount of work done.

In this blog I am not going to say what is right or wrong but I want to set a challenge on what is fair for the client.

If we consider accountants and solicitors the work they do is normally specific, so you have an accountant and you go back to them each year (or more frequently) and engage them to do specific tasks and pay an hourly rate for those tasks, or an agreed fixed fee. A solicitor will operate in the same way.

There is a strong argument that all financial planners will move to this model but herein lies the challenge, I have indicated (possible controversially) that financial planners should control all aspects of the financial planning model (or certainly be seen to be). The “be seen to be” is for example outsourcing the compliance to a network and outsourcing para planning but the key aspects i.e. the financial planning and investment strategy are controlled by the adviser firm.

This is important because the financial planning aspect is very much about a point in time, so for example it will be at the start of the journey and then through the cycle. It is difficult to put a time on things but say initial work is 20 hours and the financial planner charges £100 an hour that would be £2,000 up front. If the client pays a percentage as an annual retainer on say £100,000 that is £1,000 a year. So what do they get for that, this is the service for the financial planner to articulate; in reality this works out at 10 hour’s work a year……..

When considering it this way the percentage fee actually seems fairly cheap if the proposition is articulated correctly. But what is that proposition?  It is effectively reviewing the plan perhaps twice a year and making recommendations on the basis of those reviews. It may actually be hard to argue that it is worth 1% a year.

So how can valued be added? I believe that where the financial planner owns the investment strategy then they can add value, and the hourly rate doesn’t work because there is so much unseen work.

This is where a percentage fee works well but the financial planner needs to articulate what that proposition is. So this is, for example, how often the portfolios are re-balanced, how they manage those portfolios and what information they share with their clients. If financial planners are going to charge for it they must be prepared to share what they are doing otherwise there will be no recognition of what they do.

So what is right an hourly fee or percentage?
  1. It depends on the proposition and what work goes on behind the scenes that perhaps the client might take for granted
  2. If financial planners don’t own all aspects of the proposition then it may be harder to articulate the value in paying a percentage fee
  3. If they do own all aspects of the proposition then they must be prepared to share what they do with their clients so that they can understand it, and truly value the proposition
The debate will go on but ultimately I hope that the regulatory bodies don’t force us down one route because the right route depends on a number of factors and cannot be boxed into one corner…….

Tuesday, 25 June 2013

The biggest threat to financial planning – part 2

I recently highlighted changing demographics and debt as being one of the biggest threats to financial planning. In this blog I want to expand on the way our economy is changing in such a way that we need to change to reflect this.

In a recent presentation the presenter indicated that 54% of the UK population have no savings or investments and that this would increase. Only 22% of the population are “active” risk based investors.

If we unpack the 22%, this is split such that 3.4 million are pure self-directed investors, 5.4 million are both self-directed and advised and 1.5 million are entirely advised. It is anticipated the self-directed market will increase significantly over the coming years, and the advised market will shrink.

Before I explore further how I think the advised market can reverse the trend I want to pick up on a couple of points. Firstly the presentation indicated that 80% of self-directed risk based investors are actually not active – this is a warning sign for the future and secondly there is demand for advice but people don’t want to pay for it and I think a lot of this is around how it is packaged to investors.

Where now for the advice model?

There is a greater desire for the advice model to be seen more as a professional vocation similar to accountants and solicitors. This is very much the US model but I believe this will take many years to attain the same status in the UK (although some financial planners are already seen in that way by their clients).

So there are clearly challenges for the advice model and in a shrinking world the question is how do financial planners thrive – clearly financial planners can go down the self-directed route or phone / internet based advice route but for face-to-face advice how do they survive?

  1. I would argue that as financial planners move towards a more professional vocation the concept of financial planning becomes a commodity, i.e. everyone does it
  2. Cost is a battle ground but shouldn’t be, this is because many people don’t understand the value of financial planning and the service they receive
If we take these two points then to survive financial planners need to own all parts of the strategy including the investment proposition. If they don’t then they need to reduce their fees to reflect a reduced service, some are doing this but many are not.

Picking up on the investment strategy, nearly 50% of financial planners outsource their investment strategy. This will increase for two reasons, a drive to push down costs (although in reality the cost to the client goes up) and because of the audit trail needed to run an investment strategy.

The danger is this – as the investment strategy is more and more outsourced there becomes consolidation in the market and there are fewer and bigger brands meaning the investment investment strategy is not unique to the business and becomes a commodity like financial planning, and ultimately the financial planner is not in control of the investment decisions that deliver the client’s goals.

Investors might not see this now, but they will in the future and they will demand lower fees to reflect this outsourcing. The end result is that margins are squeezed further unless financial planners take control of all aspects of the service proposition.

Reversing the trend

As the market contracts and shrinks, the financial planners who shine will be those look forward and don’t build a business on the past. Financial planning is about road maps and accepting paths will change, it is also ultimately about taking responsibility for the engine that drives the client along path. Only by doing this can the financial planner offer a point of difference, charge and articulate a fee to reflect that difference and ultimately provide a level head when the rest of the world appears to be going crazy (i.e. peace of mind).


The world is changing, debt and demographics are shrinking the pool of those who can invest and perceived cost is driving investors to the self-directed market. This provides opportunities especially in a shrinking advised market but financial planners need to accept that they need to be seen as being in control of the whole package if they are to charge a fee that reflects this, if they are not in control of the whole package then they need to reduce their fee to reflect this and think carefully as to how they articulate what they do.

Thursday, 20 June 2013

In the midst of the fog we can’t see what is in front of us…..

In recent weeks there has been strong sell-offs across the markets. Some of the hardest hit regions are Asia, Emerging and Frontier Markets. I am a strong believer in these regions for a number of reasons, but that would take several blogs for me to expand on this.

I just want to expand on one aspect and this is the new middle class. Middle class is defined as anyone earning between $10 and $100 a day.

In 2009 there were 1.8 billion middle class people on this planet; this is expected to grow to 4.9 billion by 2030. Asia will make up 3.2 billion of this, with Europe sitting around 0.68 billion and North America 0.32 billion.

We can see the impact of this, in China 2,500 vehicles are sold every HOUR. Ghana has seen an 81% increase in car ownerships in 5 years.

India is expected to be the biggest middle class population by 2030 (475 million), Africa and the Middle East 341 million and Latin America 313 million.

There is actually good news behind the gradual withdrawal of QE in the US but this has spooked the markets, with advising clients this information is like gold dust. Why should you consider these regions and should you be reducing exposure? The reality once the fog clears is that these regions will be a major part of our lives within the next twenty years, if they are not already and volatility doesn’t change that story.

Would you be prepared to lose money every year?

When we look at risk we have this fixation that cash is the lowest possible risk asset. It is a simple assumption, you have £100,000 and assuming the bank doesn’t go bust you will have £100,000 at the end ignoring any interest. Seems a simple assumption, if you put £100,000 in the stock market you don’t know what your end result will be. So risk in these terms would put cash at the bottom of the tree.

Unfortunately this is the position of the regulators and journalists, in reality they are missing one of greatest risk assets ever……..

The story

The chancellor would like inflation to sit around 2%, the only way to do this would be to increase interest rates. Although our economy is in a stronger position it is still fragile and a sudden increase in interest rates would effectively kill any potential growth that is currently flickering into life.

We saw in June that inflation increased to 2.7%, this is bad news for those who continue to hold money in cash. Interest rates are poor and it is becoming harder to achieve anything above 1%. This means effectively that savers are losing money.

Where savings were used to provide income, clearly a rate of 1% on £100,000 will only provide an income of £1,000 a year with no growth on the capital. With current life expectancy greater nowadays those using cash to fund income have a double hit of no growth in their capital, therefore falling in value in real terms - but also a drop in income year by year in real terms.

It causes me concern that journalists and regulatory bodies insist that cash sits at the bottom of the risk scale, when in reality although there is no loss of capital: i.e. £100,000 will be £100,000 in 20 years’ time, in real terms inflation will kill this investment.

Consider £1000 of income assuming the 1% remains constant will be worth around £580 in real terms after 20 years assuming inflation of 2.7%. Equally assuming no growth on the £100,000 this would be worth around £58,000. The ‘purchasing power’ of that £ is greatly reduced – even if the balance doesn’t change.

In real terms a tank of petrol in twenty years’ time will cost £160, today it is around £93. A bottle of wine today is around £4.71, in twenty years it will be £8.13 and so we can go on.

The point is that rising inflation will kill cash and until regulatory bodies accept this we have a problem.

So what can be done?

I have said before if you have only a small amount of savings then very little, but there are options.

If £100,000 was invested in a diversified portfolio within a tax free environment and this returned 5% after charges the value of this in real terms would be around £158,000. Consider this against cash and the difference in real terms is around £100,000.

Of course the big difference is volatility the money in cash remains constant but the money in equities will fluctuate.


When defining risk we need to consider this new world, otherwise there will be many disappointed savers.  I appreciate this is hard when the regulators cannot see this but it is something that people should be made aware of before it is too late.

Wednesday, 12 June 2013

The biggest threat to Financial Planning

I have recently been posting some stats around debt, savings and income. I know some people feel that the clients they deal with don’t fall into these categories but I would argue that these trends highlight the changing society we are in. 

For a long time I have felt emerging markets will be the next developed markets; people have laughed but consider that “80% of the world wants what 20% of the world has”. Now emerging markets also have a very different profile to developed markets and in particular with regards to population growth:
  1.  In the West population growth is estimated to be less than 1% a year, on a population of 1 billion people. The average age is around 40 to 45
  2. In Asia population growth is estimated to be around 1.5% a year, on a population of 4 billion people. The average age is around 30
  3. In Africa population growth is estimated to be around 2% a year on a population of 1 billion people. The average age is 19

The point of this is the Western economies have an aging and slowing population. At the moment this group are the greatest consumers, but the market is saturated; there are only so many cars or houses people can have. The markets are maturing but they are also burdened by debt; this is not just personal debt but also economic debt which effectively stifles growth.

This is really important because we are perhaps in a sweet spot at the moment with people reaching retirement with money, and unburdened by debt. Many of this generation come from a generation where debt was not an option; they were savers and never acquired large amounts of debt.

Don’t get me wrong I don’t know the numbers but this is a healthy market to provide financial planning to and their needs are complex, longer life expectancy is something the developed world has over the emerging world but there are challenges to this. The income has to last longer, and there is greater likelihood of catching various diseases like cancer.

So although there is a booming market, this is the peak of the cycle and it is heading downwards. The idea that these people will leave an inheritance is becoming more unlikely as they live longer, and they spend more (i.e. the savings are providing for a longer period of time and therefore will reduce).

The generation coming through are fewer and different; this generation are used to debt. If you want something why save when you can have it immediately. This attitude means that debt becomes a ball and chain. Effectively, you cannot control your cash flow. So say your earnings are £2,000 a month and you pay £500 on debt then the earnings are in reality only £1,500 per month if you have rent / mortgage to pay, and other bills then you are unlikely to have much less for savings.

The argument is that as you move through life you will earn more and actually it will get easier, but in reality as you move up the ladder things change. You start a family, you want to move home, you have education costs, and in this day and age you are more than likely to lose your job at some point. If you are already burdened by debt and paying this down, the additional costs reduce your outgoings and you still have no time to save.

So we can sit there and say, sweet let’s make hay whilst the sun shines or we can do something about it. Firstly we need to be aware of the threat of debt to a client’s financial health but we also need to be able demonstrate what impact this has. For some of our client’s they already know this but do their children, can we as financial planners offer to educate the younger generation? I think the answer is yes, yes we can hold onto this sweet spot but in twenty years’ time the market needing financial planning will be much smaller.

Turning to emerging markets, we are quick to ignore these markets or consider that they have become developed. These countries are like the US in the twenties; until these countries develop proper legal and political systems they will not become developed. But in reality they will this may take a generation to achieve but when they do could it be that we become a third world country burdened by an aging population, heavily in debt and with little savings or income.

So if you ask why I send information on debt and savings perhaps just consider this message.