Paying for Your Financial Advice

An email from a reader:

Dear Gilbert,

I read your recent post, as always, with much appreciation for its practical content that impacts on Singaporeans from all walks of life. I do have a quandary though and in your post where you mentioned that you just hired a financial adviser sparked me to write to you.

I'm not exactly that savvy with my investments and I have come to a point where I seriously need to find a financial adviser that is not some run of the mill insurance agent type peddling products that I might not necessarily need at all to boost my nest.

I'm 26 and I have no qualms paying for one that could really help me before I fall back even further. Not asking for a recommendation, simply a finger to point in the right direction to find a decent one adviser and the basic points to take note of when choosing a financial adviser. Hope you can take some time off your busy schedule to write back with your thoughts.

A happy Chinese New Year to you..

Regards,
[ xxxx ]

I recently got a financial adviser, because I recently made my first investment as an "accredited investor". For me, this is a new corner of the investment universe, so I need some advice to help me get acquainted.

"Accredited investor" means an investor whose income, net assets or lump size investment exceeds certain levels, such that the law no longer regards him as an ordinary retail investor. Therefore he can be offered different types of financial products which may not be approved for the ordinary retail investor in a particular country.

But anyway, back to the question of financial advice, for the general investor.

Financial advice comes with a cost. You have to pay for it. A financial institution cannot carry on a business that includes providing financial advice, without finding some way to charge for it. Otherwise it would be losing money. Because the financial adviser is himself a fixed cost - the financial institution has to pay him a salary - and because the ability to provide financial advice needs to be backed by an infrastructure that itself costs money to run (for example, a bank's research department).

The cost of financial advice can be passed on to the customer - (that's you, dear reader) - in a variety of different ways. For example, theoretically it could be a flat fee or time-based fee (although this is uncommon in Singapore). Or it could be a trailer fee (charged quarterly or annually) on the total amount of investments you place with your financial adviser (that's "Assets Under Management", or AUM for short). Or it could be built into the upfront sales charges for the investments you make.

Let's look at the following illustration. Here are three scenarios.

Scenario 1

You are an ordinary retail customer. You walk into a bank branch. You ask a financial consultant to recommend some investments to you. She asks about your financial goals; discusses any other investments you already have; determines your risk profile through a questionaire; talks about market conditions etc.

Then she recommends XYZ Equities Fund to you. You agree. You decide to invest $10,000. You pay 5% in sales charges, which is typical for an equities fund. That works out to be $500.

Scenario 2

You are a "priority banking" customer (this typically means that you have placed at least $200,000 with your bank). You walk into a bank branch.

You ask your relationship manager to recommend some investments to you. She asks about your financial goals; discusses any other investments you already have; determines your risk profile through a questionaire; talks about market conditions etc.

Then she recommends XYZ Equities Fund to you. You agree. You decide to invest $10,000. Being a priority banking customer, you typically get a discount and pay 3% in sales charges, for an equities fund at a bank. That works out to be $300.

Scenario 3

You are an ordinary retail customer. You visit a website such as Fundsupermart or Dollardex. The website has dozens of articles about financial planning, regular updates on market news and plenty of online tools. However, it's essentially a DIY process. You do your own reading and research. No one is there to specifically talk to YOU about your money.

You then decide to invest $10,000 online, in a particular equities fund (gee, guess what - it happens to be XYZ Equities Fund). Typically, you pay 2% in sales charges. That works out to be $200.

* * * * * * * *

Note that in all three scenarios, you bought the same exact equities fund (the XYZ Equities Fund). However, in Scenario 2, you paid less than in Scenario 1. And in Scenario 3, you paid less than in Scenario 2.

Despite being an ordinary customer, the Scenario 3 ordinary customer actually got a better deal than the priority banking customer in Scenario 2. Why? Because financial advice costs money.

That financial consultant, or that relationship manager, may have been pleasant, well-informed, patient and helpful. You may indeed have found her advice clear, informative and useful. But you have to pay for that. The payment is ultimately reflected in the extra 1 to 3 per cent you pay, in the sales charge.

This is not to say that paying for financial advice is necessarily a bad idea. This is to illustrate that financial advice does come with a price - even if you are not explicitly told that it comes with a price. What you then have to decide is whether the value of the advice you get is worth the price you're paying for it.

That in turn depends on a variety of factors, two of which are (1) your own level of financial knowledge, and (2) your willingness to learn on your own.

TO BE CONTINUED ......