Six dangers when seeking super fund advice

I have been writing about, or working in or on the sidelines of the financial services industry for 20-odd years and the regulator and the advising industry are only now, in 2011, really grappling with how consumers make investment decisions and the influential role that advisers and financial organisations hold in distributing investment products.

We have reams of paper disclosing risk, conflicts of interest, fees and investment performance, as if all this paper matters. And these documents do matter, but the best disclosure in the world won’t save investors from financial loss when certain circumstances are in place.

Over the past two decades I have spoken with hundreds of advisers and thousands of investors in my various technical roles, and as a journalist and presenter, and I believe there are six main factors that determine whether a consumer/client receives quality information or advice. More importantly, one or more of these six factors also determine whether a consumer successfully protects themselves from unwise investment decisions.

Besides the dangers of greed, fear and overconfidence, the six factors are:

1. Investor ignorance

We don’t recognise financial literacy as a skill. Whether you were taught financial skills as a child can be a matter of luck. If you were unlucky enough not to be taught such skills, then you have to make a concerted effort to embrace financial knowledge as an adult.

What’s more, an investor cannot blame a financial organisation or a product adviser if the investor doesn’t do their homework. For example, if an investor places their money in a financial product without reading the disclosure material, even when they have an adviser, then it is hard to convincingly argue that they should be compensated for such an investment based on ignorance of the risks involved.

Retail investors are now offered sophisticated financial instruments dressed up as retail investments which are generally well beyond the financial knowledge of most individuals investing in such products. For example I am not a big fan of CFDs (contracts for difference) for the vast majority of Australian investors.

2. Blind faith

Some investors use financial advisers unquestioningly and fail to take the time to understand where their money is invested. Clearly, an investor can’t be responsible for an incompetent or fraudulent adviser but washing your hands of the financial decision-making is generally the first step down the slippery slope of financial loss. My experience with service providers is that a client generally receives a better service from the service provider when the client takes an active interest in proceedings.

Another common situation is where an investor relies on the advice of friends, and considers such advice as “expert”. I have seen friends and experts get carried away by an investment and who then feel compelled to encourage everyone they know into putting money into the investment as well.

In my experience, older women are particularly at risk of blindly relying on a financial adviser or a male friend for investment decisions. Of course, I don’t believe that all older female investors are likely to be in this category.

3. Commission-based advice

Advisers who receive commissions can be some of the nicest individuals that you may meet, but commission-based advice is not independent advice. The simple fact is that such advisers have to recommend products that pay commissions to make a living. If you want tax advice or superannuation strategy advice, then a commission-based adviser will only get paid for that advice if they also recommend some managed funds.

Commission-based advice means that you generally won’t be advised to invest in industry funds or direct property or cash. In the worst-case scenario, advice remunerated by commissions can cause financially catastrophic consequences. For example, the widespread recommendation of Westpoint products was driven by commissions of 10–12%, even though the product was highly risky and unsuitable for most investors.

Many of the tax minimisation schemes, for example, forestry schemes, were so common (until recently) because they were recommended by advisers who received at least 10% commissions on money invested.

A 2006 survey conducted by the Australian Securities and Investments Commission (ASIC) found that nearly half of all advisers in Australia received commissions or salary bonuses for making super fund switching recommendations. The ASIC report also found that advisers receiving such remuneration were six times more likely to provide unreasonable advice compared to those who are paid the same fee (rather than commission), regardless of the recommendation they provided to clients.

4. Trust/Transparency

Trust is a double-edged sword. A client/adviser relationship built on trust means that you are never afraid to ask questions and your adviser treats every question with respect. There are no secrets and your adviser is willing to deliver you both the good and the bad news.

One adviser I know describes the process of building trust between adviser and client as “when trust passes”. What he means is that the client lets go of some financial decision-making and delegates the transactional matters to the adviser. In some cases, particularly over a long period of time, such a trust relationship can drift towards blind faith (see also danger, ‘Investor Ignorance’).

Proper disclosure of conflicts of interest, fees, risk and tax implications also fall into this category. In an “open trust” relationship with an adviser who communicates effectively, disclosure generally includes verbal disclosure of investment and advice fees rather than hiding it in written form in a pile of client advice papers.

An adviser who communicates well doesn’t necessarily mean slick or polished, or the ability to deliver amazing presentations. In many cases, being too slick is a warning sign and strong selling skills are not the same concept as strong communication skills.

Note: A frank, open exchange is essential in any financial transaction regardless of whether a financial adviser is involved. It’s your money and clear communication should be expected when opening a bank account, investing in managed funds directly rather than via an adviser, purchasing a property, and even when nominating beneficiaries for your superannuation benefits for when you die.

5. Understanding risk

Prevention is better than cure when it comes to making unwise investment decisions, but talk to anyone who is a long-time investor and you are likely to hear tales of early investment mistakes, bad luck and, in some cases, times when they have trusted the wrong people.

Learning from investment mistakes is the surest way to avoid future investment losses, although investors also have to accept that when choosing risky investments that there is a higher risk of loss. If you’re a “no guts, no glory” style of investor then you’ve obviously prepared yourself for a rollercoaster investment experience.

If you don’t yet have investment experience, then talk to investors who do have experience, or read commentary from experts who have been in the market for a long time. For example, the spreading of risk through diversification always seems such a boring topic to write about but if one of your investments happens to collapse, then having a diversified portfolio can be a great feeling because you can take comfort in the fact that the single loss will not have a devastating impact on your overall portfolio.

6. Fraud/incompetence

Fraud is one factor that is nearly impossible to plan against, although in most cases when fraud occurs, there have usually been some early warning signs. Hindsight is an amazing thing.

Generally speaking, when fraud occurs in a company, or in a financial advising firm or a workplace, one individual often has had total control over a function, such as processing invoices and payment of invoices, or receiving of investment money and subsequent investment of that money. In internal audit language, there is a lack of internal controls. Alternatively, the culture is corrupt that creates an environment for fraudulent practices and/or there is collusion between two or more individuals who control the money flow, the information flow or key decision-making.

When fraud is committed by financial organisations or advisers, any recourse is normally through industry compensation schemes or through the courts.

ASIC has produced a six-point list (How to avoid a scam) to help investors learn how to avoid dodgy investments or advisers. The list also directs you to ASIC databases that contain banned advisers and illegal investment schemes, and a list of licensed advisory business. You can check out the list and database on ASIC’s website (www.asic.gov.au).

In relation to incompetence within a company in which you invest, you hope that your preliminary research before investing would have brought any deficiencies to your attention. If not, the market usually factors incompetence into the share price. If you have invested in an unlisted vehicle and you’re concerned about the competence of the operators, then vigilance, seeking information and monitoring ongoing performance are essential. And you can generally sell the investment, in most cases.

In relation to incompetent financial advisers, the only real checks are choosing wisely or learning from bitter experience. ASIC has produced a checklist that you can use when selecting a financial adviser. You can find the checklist on the ASIC website.

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