Financial advice: What are the risks and benefits?

Financial advisers are supposed to act in the best interests of their clients. That’s not a vain hope or fluffy belief, it’s enshrined in law.

But confidence in financial advisers has been rocked lately by a series of financial scandals and instances of serious misconduct unearthed by the Hayne Royal Commission. Most notably, fees for no service and advice that left clients worse off.

The latest annual Investment Trends Financial Advice Report (taken after the Royal Commission hearings) found that trust in financial planners and banks had fallen to all-time lows. On a scale of 0 to 10, both had fallen to 4.8 which put them in the ‘distrust’ range. Not quite on a par with politicians on 3.0 but getting closer.

So how can you protect yourself and get the most out of your adviser? Because despite appearances, there are many good advisers out there.

It starts by knowing what you are entitled to expect from a financial adviser or planner.

Under the Corporations Act, advisers are legally required:

• To act in the best interests of their client
• To provide appropriate advice
• To give priority to the interests of the client if there is a conflict of interest.

It’s not enough for advisers to pay lip service to their best interest duty, it requires documented processes and actions that clearly demonstrate they have acted in the best interests of their client. Unfortunately, that doesn’t always happen despite significant reforms in recent years.

FOFA reforms

The Future of Financial Advice (FOFA) reforms introduced in 2013 prohibited certain types of conflict of interest in the financial advice industry.  This includes conflicted remuneration such as the payment of commissions for selling certain products and volume-based payments.

Financial advisers are also required to increase their professional, ethical and educational standards under an amendment to the Corporations Act in 2017 which comes into effect between January 2019 and 2024.

Advisers are also now obliged to provide annual fee disclosure statements to clients and invite clients to opt-in to ongoing fee arrangements every two years.  Yet a lack of transparency around fees and ongoing fees for no service were major themes of the Hayne Royal Commission.

Despite these significant reforms, and the legal duty to act in the client’s best interests, too many advisers continue to offer conflicted advice. This is due in large part to the vertically integrated business model that is prevalent in the industry.

The risks of vertical integration

Vertical integration is the business model where two or more different stages of production are combined. This model has been enthusiastically adopted by our big banks and financial institutions who not only produce financial products such as managed funds and superannuation platforms but also offer financial advice.

There are obvious benefits for the institutions which can use their advice arms as a channel to sell their products, although their obligation to act in the best interests of their clients is meant to address any conflict of interest.

There can also be benefits for clients. Vertical integration produces economies of scale which, theoretically, should produce cost savings for the banks and their clients. Some people may also be attracted to the convenience of a one-stop shop and the perceived safety offered by doing business with a large, well-known brand.

As the Royal Commission heard, this perception of safety and cost effectiveness is not always the reality. Indeed, one of the criticisms of the commission itself is that it did not recommend the separation or sale of the wealth management arms of the big four banks and AMP from the rest of their business.

Entrenched conflicts of interest

The financial industry regulator, the Australian Securities and Investments Commission (ASIC) conducts regular reviews and surveillance of financial advisers. A 2018 report on one of these exercises, Financial advice: Vertically integrated institutions and conflicts of interest, found that clients’ interests often came off second best.

ASIC looked at the approved product lists of the two biggest advice licensees of each of the five biggest institutions – AMP, ANZ, Commonwealth Bank, NAB and Westpac. The aim was to see if advisers were offering products from external providers as well as their own in-house products, and to check the quality of advice and whether it complied with the best interest duty.

This is what ASIC found:

• In-house products represented just 21% of products offered (79% of products were from external providers)
• But 68% of clients’ funds was invested in in-house products. For new clients, 75% of funds invested went into in-house products.
• There was wide variation between the 10 licensees reviewed; 3 had less than 50% of clients’ money in in-house products while one had 88%.
• There was also variation across product types. In-house products accounted for 91% of client money invested in platforms (96% for new clients), 69% of money in superannuation and pensions (48% for new clients) and 65% of money in insurance (31% for new clients). There was a more even split for money invested in investments such as managed funds.

ASIC also looked at the quality of advice given on their in-house super platform and had significant concerns about the financial outcome for 10% of clients. For these clients, ASIC found that switching them to the adviser’s in-house super platform resulted in inferior insurance arrangements or a significant increase in ongoing product fees without any additional benefits.

For a further 65% of clients, the adviser had not complied with their best interest duty because they had not considered their client’s existing financial products or not based all judgements on the client’s relevant circumstances. While the financial outcomes weren’t necessarily worse, they weren’t necessarily better either.

Shortcomings of approved product lists

Advisers are not required to have an approved product list, but such lists are often used as a risk management tool. Most institutions have specialist teams to research and approve products for their advisers, to save them time and compliance worries.

However, these approved product lists can act as a barrier to advisers considering and approving clients’ existing products. Even if an adviser is not actively prevented from recommending an existing product not on their approved list, the time-consuming bureaucratic hoops they must jump through to prove the product is in their client’s best interest may be enough to dissuade them from even considering it.

As a result of its findings, ASIC has undertaken to consult with the financial advice industry on the introduction of public reporting of approved product lists and where their clients’ funds are invested. This would provide much-needed transparency for investors who may not even be aware that their adviser is part of a larger, vertically-integrated group.

Examples of bad advice

ASIC provided two case studies from the client files it reviewed that demonstrate the conflicted nature of some of the advice being given.

Case study 1

A young couple, both aged 27, with no dependents had multiple super funds with multiple insurance products. They wanted to arrange life insurance through super with ‘fixed’ cover that would not reduce as they aged.

The adviser recommended switching to the in-house super platform, cancelling all existing insurance and taking out life, TPD and income protection insurance through the new super platform as well as separate trauma insurance.

However, the adviser had not researched the couples existing funds, at least one of which offered fixed cover. Their existing funds also had lower management fees.

Case study 2

A 58-year-old single person with no dependents, employed part-time on $63,000 a year and living in rental accommodation, wanted to retire at 65 on an income of $35,000 a year. The client is anonymous, but let’s call this person Jane. Jane had no debt but some cash and $150,000 in super across two funds.

Jane wanted a review of her situation, including a consolidation of her super, life insurance cover of $75,000 plus income protection insurance.

The adviser recommended rolling over Jane’s super into their in-house super platform and taking out new life insurance cover of $75,000, TPD and income protection. This would cost her $10,857 in insurance premiums in the first year and more in subsequent years due to stepped premiums, which would come out of her super account, reducing her retirement savings.

ASIC noted that the cost of income protection increased from $132 a year with Jane’s existing fund to $7,552 a year. While the increase would provide additional cover, Jane could have negotiated similar cover with her existing fund for $2,658 a year.

The adviser justified prioritising insurance over retirement savings by referring to the need to protect Jane’s family from debt, but she had no family and no debt. ASIC also observed that for someone so close to retirement, super and retirement income should be a key consideration.

How to avoid the risks

You can avoid some of the risks of conflicted advice like the examples above, especially where the adviser is aligned with product provider, by asking questions.

For example:

• Are the products being recommended in-house products?
• Can you offer advice on my existing products?
• Can you give me a breakdown of fees?
• Can you give me evidence that I will be better off switching out of my existing products to new ones recommended by you?

See the SuperGuide article Super advice: How to find a suitable financial adviser for a list of questions you could ask.  

The benefits of good advice

Enough of the risks. Despite recent scandals and bad behaviour in the financial advice industry, a good financial adviser can be enormously beneficial.

There are plenty of surveys showing the advantages of advice. For example, the Legg Mason 2018 Global Investment Survey found that advised investors were more confident about their investment opportunities in the coming 12 months and tended to have more balanced and diversified portfolios than their DIY peers.

Appropriate advice that takes all your relevant personal circumstances into account can help you:

• Set and prioritise your financial goals
• Learn how to budget and start a savings and investment plan
• Put in place strategies to build wealth
• Protect your assets and income with appropriate insurance cover
• Get any government assistance you are entitled to
• Make sure your assets end up in the right hands when you die
• Avoid expensive mistakes.

Younger advisers catering to a new generation of investors are increasingly positioning themselves as money coaches who are there to help you make the most of your money and keep you on track to achieve your goals.

Surprisingly, while the Legg Mason survey found that 45% of Australian investors said they used an adviser, 60% of Millennials did so compared with 32% of Baby Boomers.

Professional financial advice can be particularly helpful at key points in your life. People typically think about getting advice when they are approaching retirement, with all the planning that entails.  But strategic advice much earlier in life could potentially make a big difference to your financial health.

Times when it could be an advantage to seek financial advice include:

• Starting a family
• Receiving an inheritance or other windfall
• Being made redundant.

Financial advice doesn’t have to be ongoing. You can seek advice for a single issue and pay a one-off fee for service. You may also be able to get low or no-cost advice from you super fund. (see SuperGuide article How to find low cost (or free) financial advice).

As people progress through life and their financial affairs become more complex, it is common to build a team of advisers including an accountant and lawyer as well as a financial adviser.

If you do choose to seek out financial advice rather than go it alone, it is still important to educate yourself about money, investing and superannuation.  You also need to stay well-informed about financial markets, economic trends and investment issues. That way you can assess the advice you are being given, know what questions to ask and sniff out any conflicts of interest.

If you have found your way to SuperGuide you are already doing just that.

Learn more about financial advice in the following SuperGuide articles: