Why obtaining quality financial advice will become more difficult

financial advisors

Most people would say that finding a good financial advisor has always been a difficult task. Ten years ago, most financial planners received commissions for remuneration, so clients had to navigate endless conflicts of interest. Thankfully, investment commissions no longer exist. The challenge is now finding an advisor with well-rounded experience.

Commissions are banned – it’s more about experience and scope

Financial advisors use to receive commissions from managed fund providers which created a conflict of interest, as data showed that they’d only recommend the funds that paid commissions, and the higher fees (resulting from the cost of paying this commissions) greatly diminished net investment returns. In essence, commissions incentivised planners to recommend poor quality investments (managed funds).

Commissions on new investments were banned in 2014 and on existing (grandfathered) investments in 2018. Financial advisors now cannot accept conflicted remuneration arrangements by law e.g., commissions.

Obviously, this was a massive step forward because the existence of commissions was almost wholly responsible for all the poor advice outcomes that people experienced. In a commission-based (or any conflict of interest) world, most advisors core competency was salesmanship, not delivering quality financial advice. But most unsuspecting customers didn’t realise this – often planners were wolves in sheep’s clothing.

This has changed now. Financial advisors no longer need to sell, just advise. Therefore, in my view, when choosing an advisor, you must consider (1) whether they have enough experience and (2) whether the scope of their advice maximises your opportunity i.e., knowledge.

With respect to scope, I’m a staunch believer that holistic advice maximises value, as discussed here (where I shared 6 case client studies). High quality advice is multifaceted because it includes many considerations including tax, super, estate planning, insurance/risk and so on.

The mass exodus of advisors will take years to repair

There have been several changes in the financial planning industry which have resulted in a mass exodus of advisors. In 2018 there were about 28,000 financial advisors in Australia. Around 40% of these advisors have already left the industry and it is predicted that advisor numbers will fall to circa 13,000 by the end of next year.

Of course, there were many shoddy financial advisors that really needed to leave the industry, so that’s a good thing. But more than halving the number of advisors in only five years is a terrible outcome for Australians. Imagine if that happened with lawyers, accountants, or doctors.

The problem is that as older, more experienced advisors leave the industry, there aren’t enough intermediate advisors to eventually take their place. You can’t replicate decades of experience overnight – there are no shortcuts. Therefore, the financial advisor shortage will get worse before it gets better. A lot worse!

Robo-advice has limited application

Robo-advice solutions have been lauded as a cheaper alternative to personal financial advice. Robo-advice is an algorithm-driven software tool that makes recommendations based on the answers to a series of questions. Currently, robo-advice tools provide very limited solutions.

The problem with robo-advice is that it’s a very logical tool. However, the study of behavioural finance tells us that financial decisions can be heavily influenced by emotions. Often, it is difficult to change someone’s mind with logic alone, especially if they did not use logic to make their original decisions. In this situation, a human-to-human relationship is most effective. Human beings make decisions (consciously and unconsciously) on emotions, not logic.  

I think robo-advice tools will help financial advisors a lot more than they will help the end client. These tools can eventually be used to formulate and communicate advice with clients in a cost-effective manner. But I doubt they’ll replace human advisors, at least not within the next decade.

The government ruined the industry

ASIC is mainly responsible for regulating financial advisors and it was heavily criticised by the Hayne Royal Commission in 2019. The Royal Commission found that it did very little to pursue and punish breaches by financial advisors. Since then, ASIC has handed down hundreds of millions of dollars’ worth of fines which is like stabbing the wounded after the war has been lost!

But, in my view, the regulatory system is broken. For example, national financial advisory firm, Dixon Advisory spent the best part of a decade selling its own products to its clients. These products have lost a lot of money (some almost 90% of their original value) and were ladened with ridiculously high fees that were paid to Dixons or its associates. When Dixson’s merged with listed firm, Evans and Partners, it even recommended its own stock to its clients (ASX code: EP1) – it too has since lost 80% of its value! In summary, the firm made a lot of money selling dud investments to its clients and then cashed-out by selling its business to the same clients – so they paid twice! After an investigation, Dixon’s was fined a mere $7.2 million by ASIC and promptly went into administration, presumably to avoid paying the fine and any damages to clients. No staff or directors have been prosecuted. Essentially, they have gotten away Scot-Free.

To add insult to injury, the Morrison Government introduced an ASIC Levy in 2018 that all advice firms must pay. The purpose of the Levy was to fund the cost of increased regulation resulting from the Royal Commission (which wouldn’t be necessary if they did their job correctly in the first place). ASIC recently wrote to Dixon’s clients and advised them to lodge a complaint so that they may receive compensation from a compensation scheme that ASIC Levies have funded.

In essence, the poor-quality advisors (crooks) have left the industry and the good advisors that remain are being asked to pay for their mistakes. Meanwhile, the crooks have made hundreds of millions of dollars and are probably sitting on a beach somewhere. No wonder so many advisors have had enough and are throwing in the towel!

I don’t share this story in the hope that you feel sorry for me/us. I share this story to demonstrate that the government has completely botched the industry and failed to protect Australians from these crooks. Resultantly, there’s a massive advisor shortage and the government’s not doing anything to fix it.

Rising cost of advice

I could go on and on about how the government has introduced endless and mostly meaningless compliance obligations for advisors. These have created two negative consequences. Firstly, its promoting people to leave the industry and serves as a disincentive to new entrants. Secondly, it increases the cost of delivering advice. This article in The Australian newspaper suggests that advice fees now start at $3,000 per year. I concur with this. To ensure we have a sustainable practice, our ongoing fees need to start at around $4,000 per year.

This means lower and middle income Australians will the ones that suffer

The consequence of high compliance costs is that advisors must target higher income earners or high-net-worth investors to build a sustainable advice practice. These clients have greater complexity which means there’s more scope for advisors to add value which justifies higher fee levels. There’s a limit on the number of ongoing clients an advisor can look after (around 150), so advisors must achieve a sustainable average fee level per client.

The problem is that lower and middle income earners miss out. There are virtually no advice options for them which is a terrible outcome and exacerbates wealth inequality. Falling advisor numbers makes this even worse.

The legislation that governs the provision of financial services was written over 20 years ago and is now completely outdated. So much has changed. The availability of information i.e., the internet. Financial products. Technology. Banning of advisor commissions. Even the clients have changed – back then most clients were baby boomers. The government needs to completely re-write the rules to reduce the cost and risk of providing financial advice, whilst still adequately protecting Australians. This will allow people like me to be able to offer services/solutions to clients with basic needs in a sustainable and mutually beneficial way.

Until that happens, unfortunately, obtaining financial advice will be unaffordable for most Australians.