Check the price tag on that advice

By MARY HOLM

Q: We have sold a second property for just over $500,000.

Because we seek maximum security in investing this money, we approached a financial adviser at a large bank.

The bank's advice was measured, professional and conservative.

But the cost of adopting its suggestion was, if we invested less than the $500,000, 2 per cent a year plus a 1.2 per cent monitoring fee ("offset by rebates").

If we decided to invest, say, $480,000, it would appear that it would cost almost $10,000 plus $5760, assuming the rebate did not apply. Even if it did, $10,000 seems quite high.

I would appreciate your thoughts. Is there an alternative?

A: Quite high? $10,000-plus is ridiculously high. And yes, there is an alternative.

When I've said in the past that it takes no more time to handle $100,000 in investments than $1 million, and so percentage fees don't make much sense, financial advisers have got angry.

They say the more the money, the more complexities arise, and the greater the need for wider diversification.

I suppose there's some truth to that. But I can't see that $1 million is 10 times more complicated than $100,000 - or even five times, if the percentage fees are scaled down as the amount rises.

Some good financial advisers charge on an hourly basis, like most lawyers and accountants. That would take care of added complexity in a fair way.

Again, when I've suggested this in the past, some financial advisers have protested.

"Tell someone you're charging them $2000, and they complain," they say.

"But if I take commissions on their investments that total more than $2000, they accept it, even though they're worse off."

Perhaps that's true. Perhaps New Zealanders have to get used to the idea that fees for good financial advice might be quite high.

But the ones who do charge by the hour are still in business. Often, it seems they are doing quite well.

And, after your experience, I doubt if you would complain at a first fee of a few thousand dollars.

After that, though, I don't see why anyone would need so much to run your portfolio year by year.

One of the key elements of a good initial financial plan is asset allocation. The adviser and you work out what type of investments you should be in - New Zealand share funds, international share funds, individual shares, property, fixed interest, cash and so on.

That allocation should be set according to how much risk you are happy to take, your goals, when you will need your money, and how much flexibility you require.

The adviser should not change the allocation over the years according to how the investment markets are performing.

Many do. Then they use that to justify continuing to charge you high fees.

But research shows that those who stick to their original allocation are the ones who do best in the long run.

For one thing, anyone reacting to market changes will often miss the bus. Also, moving money around costs lots in brokerage, commissions and other charges - and possibly taxes.

The only time you and your adviser should discuss changing your asset allocation is when your needs or circumstances change - although your adviser will need to move some money every now and then, when market movements put your allocation out of whack.

Let's say, for instance, that your allocation was 50 per cent fixed interest, 30 per cent international share funds, and 20 per cent New Zealand share funds.

If New Zealand shares had a boom year the next year, the 20 per cent might grow to 26 per cent. And if world shares did poorly, the 30 per cent might drop to 27 per cent. That would leave fixed interest at 47 per cent.

To get back to where you started, the adviser would sell some NZ shares and buy into the other two asset types.

This always works rather well. It means you're selling an asset type that has done well, so its prices will be high. And you're buying what's done badly, so its prices will be low.

How often should you do this rebalancing? Some advisers say once every three or six months. I think once a year is often enough. After all, what goes up will quite often come back down by itself, without your having to do costly trading.

Rebalancing does, of course, take some time and thought. So it's fair enough for an adviser to be paid for a few hours of work.

But almost $10,000? No way.

Ask family, friends and professionals for recommendations on advisers, and then ring and ask how they charge their fees.

Q: In your column several weeks ago you answered a query extensively but without first seeking clarification of the facts.

The lady inquirer says: "I will be receiving around $40,000 from a company pension plan."

My experience tells me that this will not be the only alternative on offer, and certainly not the best.

What, for instance, would be the fund manager's forecast for her pension entitlement at normal pension date if she left her current savings in the fund until then?

Secondly, is there a provision for early retirement, for instance at her present age of 55, and if so how much a year would it be worth?

In my own case, at 53 in a similar situation, I found that both of these alternatives produced a better deal than the expensive one of taking the money out, and then losing another 2.5 to 5 per cent in charges for entry into a new fund.

I took a reduced pension immediately, thus receiving 10 years of pension income before my due date for retirement and enjoying the same increases as normal retirees during that period.

Such a course of action would produce a modest but secure income for this lady immediately and for the rest of her life, without inhibiting her from seeking further paid employment.

With her husband's modest earning, what this lady needs is income now.

A: You've got a point. I guess I should have considered that there might be pension options.

In my defence, though, don't you think that the company would have spelled out the options to the woman if they were available, and she would have told me about them?

Actuary Michael Chamberlain says that, beyond the civil servants' Government Superannuation Fund and a few private companies, such options are uncommon.

He also says that $40,000 wouldn't go far as a pension, especially for a woman of 55, who is expected to live many more years.

If she took a pension now, she would get about $2400 a year, or less than $50 a week. That's so "modest" that it could easily get lost in the wash.

The money would probably be more effective invested for the long term, as I suggested - and not necessarily at an entry fee of 2.5 of 5 per cent.

Index funds, for instance, charge lower fees. And you can get into many managed funds through discount brokers for zero entry fees.

With dividends reinvested, over 10 years or more the $40,000 could grow into an amount that makes a difference.

Chamberlain agrees with you, though, that when pensions are offered and a larger amount is involved, they are often a better deal than lump sums.

What's more, he says, those who start their pensions in their 50s or early 60s tend to get an even better deal than those who start at 65.

They will, of course, get less a month, because they're expected to live longer. But it's not that much less.

So it sounds as if you took your best option.

Clever you! But you were also lucky to have that option.

PS: In your letter you commented that, in an earlier column, I used an edited version of a letter from you.

I had planned to run most of your wisdom, but the Herald ran out of space. That happens.

This time, I've submitted pretty much all of your letter.

Let's see what happens twixt the cup and the lip. If this bit gets in, all of it should have!

* Send questions for Mary Holm to Money Matters, Business Herald, PO Box 32, Auckland; or email: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number.