The ‘noble professions’ of law and accountancy have issues with charging clients and an hourly rate should not be seen as a panacea for professional standards, argues Peter Johnston.
Robert MC Brown should certainly be congratulated for his determined campaign over many years to inject some professionalism into the industry. His views on having an hourly rate-charging regime are fine in theory, but there are some structural aspects that must be taken into consideration.
Firstly, we do not have a perfect industry. The ideal environment of independent, educated advisers charging clients an hourly rate then selecting product/services/strategy from a pool of wholesale-priced commodities/products that do not have their own in-house distribution would be great for consumers and regulators. We do not, however, have that.
What we do have is a market dominated by institutionally owned advisers (85 per cent) selling their owners products and then internally cross-subsidising the practice with profits from the internal platform/product sales.
We then have an emerging market of accountants, establishing self-managed superannuation fund (SMSF) structures for clients, who are taking these administration fees away from the institutions and cross-subsidising their financial-advice practices in much the same way as the institutions do.
With all this cross-subsidising going on, it is then easy to start charging an hourly rate or flat fee to clients knowing that all the software, back office, product insurance cover and research is funded from other indirect revenue sources.
Some accountants have been criticised over the years for selling SMSF structures to get fees that may not be in the best interests of the clients. Conflicts do manifest themselves in many different ways.
Unfortunately the Future of Financial Advice (FoFA) reforms are trying to say that independent advisers cannot have a share of the administration profits to subsidise advice, but institutions and accountants can. Is that fair?
The flaws and façades of an hourly rate
I would like to see how profitable institutionally and accountancy-owned advice practices would be if they tried to survive on an hourly rate without cross-subsidisation.
It is a flawed argument trying to compare the accounting and law professions with a product-driven industry like financial services. Regardless of how you cut and dice our industry, in the majority of instances advisers/accountants are selling an administration service or investment product to clients and are accountable for their selections to the Financial Ombudsman Service (FOS), the Australian Securities and Investments Commission (ASIC) and the courts.
Accountants and lawyers have no choice but to charge an hourly rate as they only have their knowledge to sell. Many accountants tried to branch into commission-based product selling a few years ago by becoming agents of managed-investment schemes out of dissatisfaction with charging hourly rates to survive.
In theory, hourly rate charging is a sound strategy but in reality it is totally conflicted and clients (and those using it) hate it. As former chief justice of the New South Wales high court Jim Spigelman pointed out in his paper, the Tyranny of the Billable Hour, charging in this manner is an incentive to be inefficient and not entirely honest with what you charge.
The front page of the Australian Financial Review over the years has carried many stories of young graduate accountants and lawyers getting pressure from partners to ‘invent hours’ to meet their budgets.
In short, the ‘noble professions’ have maintained this façade of being ‘pursuant to the highest professional standards’ for too long. However, hourly rate charging is simply conflicted and most hate it.
Portfolio percentages and political correctness
The other area where Robert MC Brown is off the mark in my view is on charging clients a percentage of their portfolio. This is very distinct from taking a percentage-product commission, which is conflicted and rightfully abolished under FoFA.
Charging clients directly, say 1 per cent, of the portfolio’s value aligns the interests of both client and adviser. If the adviser succeeds and increases the portfolio’s valuation, they both benefit. If it goes backward they both lose. What can be fairer than that?
Clients actually like this structure, so the government had been wise staying out of this area. Unfortunately the Industry Funds and Choice have far too much to say about this, which is largely based on flawed ideology and hypocrisy.
Finally, the Australian Tax Office, Australian Prudential Regulatory Authority, all service utilities, superannuation funds, industry funds, banks, life companies, councils and state and federal government departments all charge percentages to consumers. So, why can’t advisers do so – as long as it is not tied to selling a particular product?
The political correctness and frowning upon advisers who wish to make a profit and succeed in life has gone too far.
Peter Johnston is executive director of the Association of Independently Owned Financial Planners.
Its interesting the comments about alignment of client and adviser interests. I have been moving my business to flat fees for ongoing service. I’ve had a number of clients challenge me on the basis of “where’s the incentive for me to grow their savings?” They liked the concept of a percentage of FUM as in their mind it meant that I’d be more inclined to achieve better growth for them. It was an interetsing discussion.
I countered that I dont control markets, and that it is perhaps disingenuos for me to take the credit when they go up and be penalised for when they go down. As an adviser I attempt to look after 6 key areas of their financial life of which investments is just one of them. The provision of advice over these areas and the cost is ultimately a function of what I want to achieve in terms of revenue for the time/effort/knowledge spent and the profit I want to make. It has nothing or lttle to do with how much the client has to invest.
A percentage of FUM while easy to articulate to clients, comes with some downside in terms of client cross-subsidies. Wealthier clients prop up clients that are less so. I normally frame it terms of referals. If client A has $800K invested and I charge 1%, I receive $8K pa for my efforts. Theyre happy with what they receive and refer their friend to me. They have only $400K, so my 1% gets me $4K. For a lot of firms, client A will get the same or a very similar service and experience as the friend they referred, but pay twice as much for it.
All that said, I dont think that there’s a perfect solution that fits all people and demographics. For example, many small clients cant afford or justify the flat fees we want to receive. Where does that leave them for advice? I still think comms for small clients is an OK solution. AnNd I think the notion that you should have to see them every year is nonesense for the money you receive. Comms on small clients should be treated as a ‘pre-payment’ or ‘scheduled payment plan’ for clients who may only need to be seen every 3, 4 or 5 years. That way you can see them every so often, make sure theyre on track and not have to charge them a fee which they may not be otherwise be able to afford.
Interesting to see Fergus that the fees and charges section of your website is down due to a review.
It has been a long time since I have read anything as sensible as this article.
Well said Peter and well done Professional Planner for publishing it.
A breath of fresh air in an industry which feels like it is going insane.
At last! A reasonable argument regarding billable hours. Before anyone jumps up and down, I am just saying it is a system with issues just like any other. It seems to me vested interests are demonising the people who started helping people through financial advice. That is, shock horror, the fund managers and life companies. They just like accountants, Choice and Industry Super Fund employees need to charge a fee somehow. Is their system perfect, can it be improved? The answer is no and yes but I think we can in a balanced and reasonable way say that about any area humans are involved in. I am sick of hearing the extreme views we see everyday. i suppose though we will always hear about 1% of the issues 99% of the time. I wish we could have a balanced discussion with those involved actually acknowledging their own bias and conducting themselves in an adult way. Whew! That feels better.
Great article, why is it so difficult for others to see that this makes sense?
Very well said Peter, you make some excellent points. Charging a percentage of a client’s portfolio ensures that the interests of the client and planner are aligned. As I have said previously, the method of charging a client has nothing to do with the integrity of the advice provided.
An excellent article and one a long time coming.
For better or worse, when a principal pays an agent for a service or advice there is a conflict. This conflict exists if the agent is an accountant, solicitor, doctor or dentist. This conflict between the principal’s best interests and the agent’s self-interest exists regardless of whether remuneration is paid by way of an hourly rate, piecework rate, by way of a percentage or by way of commission.
That our industry needs to become more professional is generally agreed. However, to much time and energy has been wasted on trying to eliminate a conflict of interest that not only exists in all other professions but, as long as the adviser expects to be paid, cannot be elimated.
The time and energy wasted on this single discussion has been at the cost of productive and meaningful discussion of those things that genuinely define what it is to be a professional: high standards of education, meaningful self-regulation and an obligation to put the client first.
Hi Peter, thank you for your article….did you know that there is an alternative to charging an hourly rate and a percentage of assets (real estate agents call their % of the sale a commission….paid by the client….so why not you also call an asset based fee a commission also?)…the alternative is pricing a job (initial advice and ongoing) and charge a flat dollar fee…then each year…engage with the client and renew the contract….perhaps increasing the fee by inflation…or even increasing the fee due to the anticipated additional work / advice to be provided in the coming 12 months…
As a business the adviser knows what they will be paid and for the client they know exactly what they are paying and for what advice and services…..
Surely it is in the interests of the AIOFP to work with their members towards a flat professional (not hourly) fee structure and annual client engagement…if this had previously occurred OPT-IN would never have been necessary.
PS – it is often written that clients like the commission / asset based fee structure…when often they are not given the option of another form (besides scarey hourly charging) remuneration – how can anyone say that they prefer this methodology of charging…when they have not actually and properly surveyed nor explained the alternatives to their clients.
Yes other organisations charge asset / % based fees….including used car sales people / real estate agents etc…I would suggest that Financial Planners want to be perceived as advisers ….and not sales people.
Good luck to all advisers in the coming 24 months….many changes ahead.