Flawed plans flunk the test

Finding good financial advice can be daunting; there's a lot of money at stake and it may be years before you know if you chose well.

The task hasn't been made any more encouraging by an Australian report released this week, which is less than complimentary about the work of many financial planners.

While the report is specific to Australia, it also has some lessons for New Zealanders looking for someone to help them make the right financial decisions.

The report details the results of a mystery shopping exercise which aimed to find out how well financial planners did their job.

Carried out by the Australian Securities and Investments Commission, which regulates investment markets in that country, and by the Australian Consumers Association, the exercise involved 53 volunteers, each of whom approached three financial planners. The volunteers genuinely wanted financial advice and sought a plan for their own circumstances.

A panel of experts who assessed the resulting plans were not much impressed; only two plans scored a "very good" rating, another 59 were either "okay" or "good" and the remaining 63 ranged from "borderline" to "very poor".

There's no way of knowing whether New Zealand financial planners would have performed any better, but the report does provide some lessons for anyone looking for financial advice on this side of the Tasman.

The one lesson that leaps out is this: know how your financial adviser gets paid, and be wary of the way commissions influence the advice you get.

As in New Zealand, many Australian financial planners receive commissions from organisations such as fund managers and insurance companies. If you follow an adviser's recommendation and put, say, $10,000 into a unit trust, the fund manager will reward the adviser with a payment of several hundred dollars.

As well as up-front commissions there are more subtle forms of payment, such as continuing commissions to the adviser as long as you stick with the investment in question. Then there are "soft" commissions, such as free holidays or financial rewards for advisers who reach certain targets.

Given that the vast majority of New Zealand advisers rely on commissions for some or all of their income, this raises a question: does the adviser recommend the best investments for you, the client, or the best investments for them, the adviser?

The Australian study found that commissions did influence the advice given and that the quality of that advice was significantly worse if the planner was paid only by commission.

Several of the judges observed that clients' interests did not appear to be the sole factor in the strategy of many financial plans, or the selection of investments, and that planners were often driven by the need to make commissions.

Advisers often ignored recommendations that may be better for the customer, though less rewarding for the adviser. For example, few plans recommend paying off the mortgage rather than investing cash.

And the study says that when it came to choosing specific investments, many plans didn't recommend the lowest-cost option, again raising suspicions about the effect of commissions on the advice given. Only one plan recommended an index fund, for example.

Where advisers did disclose their commissions, they were often presented in a confusing way, for example by mixing up percentages and dollar amounts, and some were suspiciously silent on "soft" commissions.

For New Zealand investors, the message is simple: ask.

That is, ask how much your adviser stands to gain if you follow his or her recommendations, get the answer in writing and make sure you understand it.

By law, advisers must tell you whether they will receive any money from anyone else, apart from you, in connection with the advice they give, but only if you ask.

The Government is considering a recommendation from the Securities Commission which would require advisers to volunteer information on commissions, without having to be asked for it - as some already do - and would widen the definition of the types of income that have to be declared. But the law is not expected to change until next year at the earliest.

If you're worried about the impact of commissions on the advice you get, try to find an adviser who will work for a fee, paid directly by you, and who will pass on any commissions he or she receives.

The advisers who rely on commissions, as many do, obviously see no problems with the practice. The organisation to which many of them belong, the Financial Planners and Insurance Advisers Association, believes such payments should be disclosed, but doesn't believe they prevent people getting good advice.

Not everyone agrees.

Economist Gareth Morgan, who runs his own investment advisory business, has called commissions a "deep-rooted swindle", arguing that advisers' income should come from one source only - fees paid by investors.

In Britain, a report commissioned by the Treasury last year concluded that commissions did affect the advice given and recommended that people giving financial advice should not be able to call themselves "independent" or even use the word "adviser" if they accepted commissions.

Susanna Stuart, senior financial adviser with PricewaterhouseCoopers, says it cuts both ways; advisers need to disclose commissions, but customers also need to realise that you don't get anything for nothing.

She says advisers should disclose their potential commissions clearly, so customers know exactly how much they're paying.

"They have to spell it out in dollar amounts rather than just percentages; if you say 5 per cent it doesn't sound much but if you say 5 per cent on $100,000 is equal to $5000 ... "

In many cases, especially when dealing with large amounts, commissions could be more expensive than up-front fees.

Ultimately, it's up to the customer to decide, but as the Australian study shows, a bit of "buyer beware" does not go amiss.

* To contact Personal Finance Editor Mark Fryer, write to: Weekend Herald, PO Box 32, Auckland. Ph: (09) 373-6400, ext 8833. Fax: (09) 373-6423.

* Email Mark Fryer