I was recently asked to review a number of files, looking at investment recommendations made by financial advisers for their clients. One thing was obvious; most advisers set out to get the best outcome for their clients but little mistakes in recommendation, research and report-writing stage can let you down big time! In a series of posts, I will highlight a few common errors I have seen and what advisers ( or ideally their paraplanners) can do to avoid those mistake, improve clients outcomes and stay/get on the ‘good side’ of the regulator.
Is a switch really necessary?
This is one question that we feel should be asked in every time before recommending a replacement investment business; can you achieve a portfolio that matches client’s objective, attitude –to risk and the need for tax efficiency using funds available in an existing plan?
At What Cost?
One key area of where recommendations fall down is cost comparison. The short-comings range from where:
- Adviser has recommended a new portfolio to replace the existing one but has done no comparison at all
- A new portfolio was recommended but the ONLY statement indicating cost comparison is ‘the cost on the new portfolio is lower than your existing investments’
- The adviser has done a cost comparison of the existing and recommended portfolios but has failed to include their own fees in the comparison
Comparing Apples with Pears
Sometimes the problem isn’t that the client report does not include a comparison of cost, it often does. The real problem is that full comparison is not being made, particularly to include the cost of initial and ongoing fees.
Off course it helps if the cost of the new portfolio is lower and no justification regarding costs is required (makes the adviser’s life easier?) but you must show that a comparison of full cost has been carried out. Additionally, you may still need to provide justification of why you think switching is necessary in the first place. (We’ll cover this is a separate post)
Mind you, it does not follow that if the recommended portfolio has higher cost, the recommendation is automatically unsuitable. It comes down to whether the higher costs are necessary, justifiable and matched by equivalent benefits valued by the client.
Here is a list of steps to include in the research and report-writing process
→ Disclosure and comparison of ALL costs on the recommended portfolio, including platform fees, adviser initial and ongoing fees as well as fund trading costs. Yeah… fund trading costs ( please don’t shoot the messenger). The fact is the FSA expects advisers to include fund trading cost in their cost comparison. ‘Firms should consider all the costs associated with the existing investment and the recommended product or portfolio. For example, firms should consider the impact of any trading charges levied on the portfolio. Where costs are variable such as trading costs, reasonable assumptions should be made about the extent of these charges. (FSA GC12-06 Paper Pg 9 of 26).
None of the files I have reviewed so far considered fund trading costs in their comparison and I doubt very much that most advisers are doing this.
→ Provide an illustration of effect of cost on investment in all cases: Consider using reduction-in-yield figures to demonstrate cost comparison
→ If the cost of the recommended portfolio is higher, what is the justification?
- Is it because the client is currently receiving no advice/review on their existing portfolio and the additional cost is because client is having access to an adviser? It is important to confirm that the client wants/value a regular/ongoing review of their investments. In my view, this is a reasonable justification. For instance; it may actually turn out that if adviser’s fee is added to the existing plan, the costs may be more than the recommended portfolio. Please not that this is NOT the same as recommending a switch on the basis that the existing plan does not allow the ability to facilitate adviser charging.
- What additional benefits is the client receiving as a result of this additional cost and are these benefits valued by the client? It’s well and good to have ‘a 24/7 online platform with consolidated tax wrappers and almost unlimited investment choice’ but does the client want or need these? What is the point in having 2200 pairs of shoe if the client is only ever going to wear 10, may be 12 of them?
- Is the increased cost justified by the expectation of better investment performance? In this case, a justification of why you think the recommended portfolio is, after costs, will outperform?
→ As part of you overall process, consider a limit on acceptable cost of replacement business or at least setting up some sort of traffic sign type warning system for additional cost.
Often the line between a well-researched and articulated switching recommendation and a borderline or outright non-complaint file isn’t massive. We belive that by taking some of these small yet crucial actions, an adviser can increase the qualify of their recommendations and reports