By MARY HOLM
Q. You and your correspondents may be missing the point in discussing how financial advisers should charge.
Advisers are only of any use if they produce better returns than fixed deposits in the bank (the no-brainer, conservative investment strategy).
Under a fair fee structure, the adviser should receive a percentage of returns better than fixed deposits.
Example:
* Assets controlled by the adviser: $100,000.
* Fixed deposit at 5 per cent. Return: $5000.
* Annual return based on adviser's input: $10,000.
* Difference: $5000.
* Adviser receives, say, 10 per cent of $5000 = $500.
This is very different from charging a percentage of assets, which is criminal because the adviser can do badly and still benefit from a reducing asset.
Example:
* Assets controlled by the adviser: $100,000.
* Annual return based on adviser's input: $3000 (quite common over the last two years).
* Adviser receives a percentage, say 1.5 per cent, of $100,000 = $1500, which is all the client is left with, too!
A definition of returns is assets at December 31, plus interest, dividends through the year, minus assets at January 1. Incidentally, it took my father nearly a year to extricate his portfolio from his former adviser's control.
A. What you say has a lot of appeal. But is it realistic?
It's not always the adviser's fault if a client has poor returns some years. The last two years are good examples.
Arguably, any client who has money they don't expect to spend for 10 years or more - which would be most clients - should have at least some invested in international shares.
Clients with large international share investments would have had negative returns in 2001 and 2002. And many more wouldn't have beaten bank term deposits, because their international share holdings pulled down returns on other assets.
Advisers couldn't do anything about that. They can't control world markets.
And yet many advisers under your scheme would have received little income in the last couple of years.
As long as they have invested their clients' money responsibly, things should come right. But can we expect high-quality advisers to put up with years of very low income?
Maybe. Perhaps an adviser who has done well enough in the past to fund themselves through bad years could set up a charging scheme the way you suggest. They might be flooded with clients.
I worry, though, that they might end up being overly conservative with clients' money - perhaps putting lots in fixed interest - just to make sure they get a minimum income.
For more on the subject, read on.
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Q. In any rational analysis of the fees paid to a financial adviser, should not one start with an easily accessible baseline? Then the fees should be related to the value added above that benchmark.
Fortunately, such a benchmark is readily available in Government stock, commonly referred to as a "risk-free" investment.
It involves no fees, so the return is simply the yield (pre-tax) for which it is purchased.
Held to maturity over five or 10 years, this is the benchmark against which all financial advisers should be compared and compensated.
Why would the fees not be calculated simply as a percentage of the return - say on a moving average basis - that the financial adviser earns over and above the risk-free rate, which represents the value they have added? The fee might be 25 per cent of returns above risk-free, plus 2 per cent.
A. Some good embellishments on the last correspondent's idea.
Government stock runs for longer terms than bank term deposits. Most advisers' clients are saving for the long term and it's fairer to compare investments of similar terms.
Also, there would be no debate over which banks' interest rates to use. And I like your idea of using a moving average of the client's returns.
For those unfamiliar with this, each year's fees might be based on the average return over the last three, four or five years. That smooths the ups and downs of markets.
And adding a standard 2 per cent, or whatever, to the percentage of returns above the government stock rate also means advisers would get at least some income in bad years.
With these features, a performance-based scheme might just be workable. How about it, advisers?
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Q. Just as an investor should match their investments to their needs and objectives, so should they match their choice of advisers, services and fees. That way they avoid the risk that you identified, of inadvertently taking on the adviser's risk profile.
Here's my fees-for-all-seasons guide: Hourly fees and/or brokerage and commissions are more suitable for investors:
* Requiring only investment placement, purchase and sales services. (Use brokerage-based discount and internet service providers.)
* With little money, seeking basic but expert advice to get started. (Use a stockbroker or financial planner.)
* With most or all of their portfolio invested conservatively in NZ$ fixed interest. (This avoids greater erosion of fixed returns under alternative fee structures.)
* With the confidence to complete their own investments, but requiring timely expert advice and assistance with placing, purchasing or selling investments. (This service is traditionally provided by full service stockbrokers.)
Percentage of portfolio fees is more suitable for:
* Investors wanting custodial and monitoring services and regular - usually quarterly - detailed reports for a balanced or growth portfolio. (This is traditionally provided by financial planners and full service stockbrokers.) Performance-based fees are more suitable for:
* Investors wanting aggressive growth investment management services. Investors must accept that both they and the adviser/fund manager can win hugely, but if it doesn't work, the investor can lose capital, while the adviser or fund manager only loses the possibility of a fee.
A. Brilliant! You've obviously put lots of thought into this and it makes sense. Many people don't choose an adviser on the basis of how they charge. But after reading your letter, perhaps they should at least make that a dominant factor in their decision.
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Q. I hope that New Zealand can avoid the situation in Australia where the complexity of their superannuation and capital gains tax regimes, combined with significant regulatory requirements for advisers, means that it is becoming difficult for all but the most wealthy to access and pay for a qualified and expert regulatory-compliant adviser.
No one else can afford to pay the hourly based fee required to cover the hours needed to fully meet regulatory and compliance requirements.
There are enough barriers to getting good advice without onerous government imposed requirements preventing this.
Coincidentally Commerce Minister Lianne Dalziel last month announced new regulatory proposals for advisers.
They do not appear unreasonable, but the devil may be in the detail.
I hope that you and your readers will take an interest in these proposed changes as further details become available, and will write to the minister or actively make submissions on the draft legislation.
The relevant cabinet papers can be viewed at
. Click on "Whats New" and, under 24 July, click on "Strengthened Securities Trading Law".
A. Good point. In the end somebody has to pay for regulation and it usually ends up being the consumer.
Still, you've got to admit that some New Zealand financial advisers need restraint. As is often the case, there's a happy medium.
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Q. Your persistent use, and promotion a couple of weeks ago, of the incorrect plural of "index" I found sad.
You describe the correct plural, "indices", as "obscure". Turn to page C10 on Saturday and you will find three columns headed "World Indices". They appear six times a week. You appear once.
I hesitate to point this out, but you are thumbing your nose at your employer! Much too late in my working life I found such behaviour did not pay. Will you learn from another's mistake?
A. And there I was thinking I was giving readers advice about money. Instead, it's you giving me advice about how to stay employed.
I should accept graciously, I guess. But I can't resist reporting that my Oxford and Websters dictionaries give both "indexes" and "indices" as plurals, with "indexes" listed first.
I dislike "indices" because I think people who use words like that are showing off that they studied Latin at school. This is not resentment. I studied Latin too. But "index" has for centuries been an English word, so let's treat it like one.
More importantly, I don't think it's obvious what "indices" is the plural of. (And please don't tell me off for ending a sentence with a preposition. You're allowed to do that these days.)
Not long ago, at a press briefing, Stock Exchange boss Mark Weldon used the non-word "indice", singular, several times.
As for the use of "indices" elsewhere in the Business Herald, when I started this column I checked to see if the newspaper's style book insisted that I use that option. It didn't. So I've felt free to use "indexes" ever since.
But perhaps I should be a bit quieter about it in future. "Sorry, boss", she says, thumb firmly in lap.
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Q. Don't let them get at you.
I still enjoy and appreciate the wide-ranging topics and advice.
A. Thanks.
This was among the kinder responses to last week's column.
We will no doubt be returning to this topic in the future.
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Mary Holm is a freelance journalist and author of Investing Made Simple.
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