Can You Imagine?!
Earlier this year I came across an interview with Adele Martin, a successful financial advisor in Australia (XYPN Radio Podcast Ep #74). Adele discussed changes that Australia’s regulatory bodies have adopted in recent years to protect consumers from poor but popular practices within the finance industry. I think they’re onto something.
A Novel Approach
In 2012, Future of Financial Advice (FoFA) legislation was enacted in Australia. The first part of the legislation banned commissions related to the distribution of financial investment products. The second part of the legislation largely focused on transparency and fair disclosure related to all financial advisor fee arrangements.
An attack on commission-based selling of financial products is nothing new. In the U.S., commissions have been heavily scrutinized and are a major motivating factor behind pending fiduciary reforms (Is Your Advisor Conflict Free?). On the other hand, legislation aimed at requiring more transparent disclosure of all fees is quite novel. As far as I know, Australia seems to be a thought leader around this type of comprehensive regulation.
As Adele explains it, the FoFA requires that all advisors:
- Have a service package in place that explains services that will be delivered to the client.
- Send an annual fee disclosure statement to clients that states whether the agreed upon services were delivered, and what has been charged.
- Require clients to opt-in to ongoing services every two years.
To the logical observer, these requirements appear pretty reasonable. Advisors have to tell clients what they are paying for, confirm that it was done and ask the client to agree to pay for services every couple of years. Nothing crazy.
Not So Fast
Much of the financial advice industry would have a different reaction, though. I was recently discussing this legislation with another advisor and the first thing he said was, “Can you imagine the reaction of the industry in the U.S. if similar legislation was proposed? Heads would explode!”
And he’s right…heads would explode. Advisors would complain about the cost of compliance and how it would hurt their business and ultimately consumers. They would draw parallels to other industries and talk about the “slippery slope” of regulation.
Just as there are plenty of ridiculous arguments in opposition to the fiduciary rule (a rule stating advisors have to act in the best interest of their clients), there would be similar opposition to any proposed legislation that resembled Australia’s FoFA. Although most arguments against any proposed FoFA-like legislation would be absurd, there are some reasonable ones.
One contention would be as follows:
Why do we need a regulatory body to require this when clients can request it for themselves?
That’s a fair question but let me propose a better one:
Why aren’t more financial advisory firms doing the types of things being proposed in Australia’s FoFA on their own?
The Sad Current State
Allow me to share a few examples of questionable, but common industry practices I’ve come across in the past couple of months.
- A woman was referred to me who had an $800k IRA at one of the largest financial institutions in the country. The institution never discussed a financial plan and had almost no interaction with her during the five years since establishing an account. Outside of annual rebalancing, there had been no activity in the account. For what was essentially rebalancing services, this client was being charged $8,000 each year (just a small 1%). To put that in perspective, it was costing this woman $8,000 annually to custody assets and have an advisor push a button to rebalance the portfolio. And, in all likelihood, the rebalancing happens algorithmically (as it should) and the “advisor” doesn’t have to do anything.
- A woman had a $100k IRA held at a large regional bank. The account was opened seven years ago and with the aid of a basic risk tolerance survey, was invested in a 90% bond, 10% cash mix. The “advisor” at the bank never asked to review the woman’s situation and had no idea what her actual financial profile looked like. Each month, a $125 “IRA fee” was withdrawn from the account ($1,500 a year). After some very basic due diligence, it became clear that not only was the portfolio allocation completely inappropriate, but paying $1,500 a year to custody a relatively small, passive bond portfolio isn’t exactly good value.
- It took Andrea Fuller, a journalist for the WSJ four phone calls with three different advisors at one of the nation’s largest advisory institutions before she had any idea what fees she was paying on her investment account. She is still waiting to hear from somebody who can give her a definitive answer.
Based on these examples, does it sound like the industry is focused on doing what’s best for their customers? These aren’t outlier events. Each situation deals with a large, well-known financial institution. The fees being charged are relatively standard across the industry. It is
It is time to stop passively accepting such standards as reasonable.
Do consumers have a responsibility to understand fees and question the value of services? Yes. This doesn’t mean, however, that we should ignore institutions that clearly seem to be operating with the attitude, “Let’s see how long we can get away with this.”
At some point over recent decades, the economics of the financial advice business became largely disconnected from the ideals of the actual practice. Charging obscene amounts of money by way of asset-based fees for something like rebalancing is not an effective use of scale. It is an outright abuse of it.
If consumers are being taken advantage of, why is much of the industry so hesitant to change? Our answer is likely found in a famous saying from American author Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
A big part of the financial advice industry relies on “Ignorance is Bliss Finance” to keep the lights on. Unfortunately, as the onion gets peeled back, the industry will have a very hard time answering tough questions. It might seem obvious, but if advisors want to be successful in the future, they need to build trust by acting trustworthy. Proactively reviewing the appropriateness of fees as related to the services being provided is a great place to start.
The idea of value-based selling seems to have many people within this industry confused. Advisors should be asking the question, “How can I provide real value to a client at a reasonable cost for my efforts?” Instead, too often the value proposition exploits the complexities of personal finance to squeeze excessive fees out of clients without logically justifying the dollars being spent. The business of financial advice wins while the practice and the consumer suffer.
My advice to consumers…ask questions. Lots of them. And demand clear answers. Australia has the right idea. Change doesn’t have to be forced by regulation, but
Australia has the right idea. Change doesn’t have to be forced by regulation, but in this case, adopting legislation similar to the FoFA in the U.S. would be a big win for consumers and the practice of financial advice.
At Ariadne, I work closely with families and individuals to organize their finances and utilize their resources to design a life they love. If you are interested in a straightforward, no-gimmick approach to financial planning that focuses on you and your needs, don’t hesitate to get in touch. I’d be happy to have a conversation.