Going back to the basics of financial planning

As the Government considers the way forward on the Future of Financial Advice reforms, Money Management publishes the following open letter written by a senior Melbourne financial adviser to the Assistant Treasurer, Bill Shorten, questioning the underlying agenda.

Dear Minister Shorten,

Your stated goal is to eliminate any financial planner conflicts regarding the provision of investor advice by removing volume payments on administration platforms.

Therefore, disclosing conflicts — along with the new duty of care requirements — is not considered adequate.

I make two observations.

Firstly, at the same time as moving to remove these volume payments, you appear to be totally happy with investors being provided absolutely no choice of platform or investment from manufacturers who are also distributors (ie, industry funds, banks, etc).

These groups are totally conflicted in both areas.

Secondly, while claiming that planners cannot handle conflicts with disclosure and duty of care, you are able to handle your massive conflict of interest and possible personal compromise as head of your department.

Your previous employers were unions and you currently rely on their backing in parliament. Yet here you are now making rule changes that not only impact the union industry funds, but significantly help them. In the corporate world you regulate, this would not be allowed. Two-faced? Double standards?

I cannot understand why ‘choice’ with fully disclosed conflicts is unacceptable, but having no choice with a 100 per cent conflict is acceptable. Having nominal or no choice has two very important impacts on investors: firstly, a financial cost; and secondly, the need to understand what ‘financial advice’ means.

What is advice? I regard advice in three parts.

Firstly, the personal issues around an investor’s circumstances, time lines, future plans, risk profile and so on. This is a significant aspect that is most important for investors.

Secondly, once invested, what is the value from time to time, and how has the investment been ‘performing’? Typically this is simply about reading periodic reports that are automatically generated and often on the Internet 24/7. The adviser’s contribution is quite minimal.

Thirdly, reviewing the investment holdings of the selected provider/manufacturer. Investors need to know if there are better opportunities.

It is only in this way a better financial outcome can be achieved than a ‘simple index’ result. This is a significant part of the adviser’s role.

Any organisation that is both the manufacturer and distributor are unable to provide the third vital area of advice, as to whether there are better opportunities for the investor.

Therefore industry funds and other large organisations distributing their own offering are totally compromised and investors need to be informed that they are only providing partial advice.

Such groups must be required to clearly detail that they only provide limited advice and direct the investor to seek independent advice about the merits of their investments.

You could adopt the same principle as your new adviser opt-in plans.

For instance, you could require investors to source a proper independent review every three years. In this way clients will often be informed at such a review about how a single investment manufacturer — used for even 15 years or more — will only achieve an index outcome. This usually can be available at a saving of at least 0.3 per cent per annum, with a resulting huge impact on the final financial outcome.

Then there is the financial cost. Every fund manager and business has differing success over time, varying from good to average and poor.

This will almost certainly be the case over the 30 to 40 year timeframe of a working adult. Investment managers are continually making predictions about the future, and to perform better than the relevant investment sector index they need to get more predictions correct than wrong. It is generally recognised that more underperform than outperform.

History also clearly shows that simply investing with one manager over the long term will at best provide an index result.

Therefore joining an industry fund or single manager personal super fund for your working life will achieve no better outcome than an index fund equivalent, with a much lower cost — a saving of probably 0.3 per cent to 0.4 per cent per annum.

Further to this is that if the industry fund being used is one of the largest three, their very size ($32-$15 billion) will almost guarantee this result.

With the increase in level and wage growth together with compounding, these funds will become so large that it will be impossible in the Australian market to add any value.

You have actively promoted the need to remove trails on super because of the impact on returns. Will you promote the ability to make a similar saving by index investing with the same enthusiasm?

Investors often gravitate to large well known investment providers often for the extra comfort and peace of mind. But these people need to be fully informed.

Firstly of the conflict of interest relating to any lack of choice, and secondly that the advice being provided is limited. Thirdly, in missing this vital aspect of advice is the extra cost they pay for the name, given the very likely financial result that will be achieved from a long-term investment relationship.

I look forward to your guidance.