Have you seen an advert for “free” financial advice? Some financial advisers market their advice as “free” but there is a cost …
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Financial adviser or financial planner?
What’s the difference between a financial adviser and a financial planner? Its difficult for most people to know the difference so here’s my thoughts.
According to the FSA there are 28,835 regulated financial advisers in the UK as at June 2011. Of these, there are just under 2,400 Chartered Financial Planners, and less than 1000 Certified Financial Planners, and this includes individuals with dual Chartered and Certified Financial Planner status as well qualified people who do not actually advise clients. That’s a small proportion of the total. Generally, advisers do not have to be qualified to this level, so these people have done this voluntarily, principally because they want to set high standards of advice.
Currently, in order to have a licence to advise the public, advisers need to be qualified to QCF level 3, which is thought to be the equivalent to an A level. The Retail Distribution Review (RDR) is due to be in force on 31 December 2012 and advisers will need to be qualified to QCF level 4 as a minimum by then. There are currently thousands of advisers not at this level who need to raise their game, but who nonetheless describe themselves as “fully qualified” under the current rules. Chartered and Certified Financial Planners have qualifications at QCF level 6, thought to be equivalent to a third year degree.
When completing a fact find, financial advisers will ask questions like “How much life cover do you need?” and “How much income will you need at retirement?” Typically, the answers lead to gaps into which financial products can be sold. Fair enough if that’s what you want, but most people have no way of properly answering these questions. There is no context. Questions about current expenditure are asked only really to ensure affordability of any product recommendations.
When completing a fact find, financial planners will use the data gleaned to create a picture of your financial future, probably with a lifetime cash flow forecast and based around your current lifestyle cost and expected future desired lifestyle cost. In effect, rather than asking you questions about what you think you need, the financial planner will tell you what you need because they will give you context.
I believe that the key to financial planning is a detailed analysis of the current lifestyle costs, and thought about how they might change in the future. Now you can think about the ways in which you can use your assets to meet the liabilities. This may or may not involve new financial products.
UK planners serious about financial planning will typically be members of the Institute of Financial Planning (IFP) and will have been through the Certified Financial Planner licence training and assessment process and have the CFP designation. In my view, if you want financial planning, this is what you should be looking for.
To find out who you are dealing with here are 10 Questions to ask your financial adviser
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Why the answer is… nothing
The media once again delight in the bad news stories associated with the fall in equity markets. Why do they rarely ever mention rises? Vested interests perhaps, around the sale of newspapers and a need to market ‘noise’ which leads us to worry and want to do something?
Behavioural finance is the study of our emotional responses to, in this case, investments. A subject which fascinates me enormously.
Economist Ofer H. Azar at Ben-Gurion University of Negev in Israel conducted a study of “Why goalkeepers dive”. It went something like this. Statistically speaking, when faced with saving a penalty, a goalkeeper has something like a 13% chance of saving a penalty if they dive to the left or the right, but they have a 30% chance of saving the penalty if they stand still. Faced with these odds, why do goalkeepers dive? Why not stand in the middle of the goal and give yourself a better chance to make the save? It seems the answer is called ‘Activity bias’. In other words, the goalkeeper feels that he must be seen to be active even though, in reality, he damages his chances of being successful. Irrational right?
Does this sound familiar in the context of investments? When markets are volatile as they have been recently, there is a feeling that we should be ‘doing something’. That somehow by doing something we will give ourselves a better chance of a good outcome. Academic studies have shown that activity generally delivers worse, not better outcomes.
There are two problems typically. Firstly, by being active we increase costs which are a drag on performance anyway. Secondly, by making bets we have to continually be right about the bets we are making or at least get more right than we get wrong. This is when investors sell at market lows and buy at market highs and we’re doomed to fail. In other words, even more activity.
The answer, I believe, is to design a well thought out strategy, put it in place and leave it alone. It goes against all our instinct when times are as they are, but this is the best chance we have of getting a good outcome, no matter how uncomfortable it might feel.
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Understanding investment risk
Stockmarkets have fallen by 11% in the last three months and are nearly 15% down on the year to date. The last three years have seen enormous swings in investment values, and I know there will be people struggling to make sense of what to do with their investments.
When providing financial advice and especially for investments, it is vital that advisers take account of your attitude to risk. Back in the old days, assessing risk involved asking you whether you were low, medium or high risk. Almost everyone said medium but neither investor nor adviser understood what each other meant by “medium”. The problem is that there is no standard measure of risk and definitions are open to interpretation.
What do we mean by risk anyway?
Risk of what? You probably associate risk with the chance of losing your money or experiencing a significant fall in capital value. What about the risk of not achieving your objective or the risk of losing money in real terms over time.
For example, holding capital in cash deposit accounts over the long term will involve minimal risk of capital loss or volatility, but will guarantee inflation risk. In effect, you are guaranteed to lose money in real terms, because cash deposit rates are lower than inflation over time. But does this actually matter? The answer will depend upon your circumstances and your views.
Risk tolerance, risk capacity and return required
Risk tolerance is the extent to which you are emotionally prepared to deal with an unfavourable outcome. Unfortunately, many advisers focus only on risk tolerance as a measure for investment recommendations. Typically this will involve the completion of a risk tolerance questionnaire, which leads to an investment portfolio model, based on the greatest amount of risk you are prepared to tolerate. You end up with the riskiest portfolio you can stomach, irrespective of your actual needs.
Assessing risk tolerance on its own is not enough. We must assess the risk (return) needed from the investment over a period of time, and also your capacity to take risk. For example, if you are emotionally risk averse but need a return of 9% per annum after taxes and charges to achieve your objective, a low risk strategy will be inadequate in meeting the objective. You will have to make a trade off decision:
• Accept the greater risks associated with the level of return needed, or
• Commit more money to reduce the risk to an acceptable level or
• Accept that the objective will be met later than required, or
• Give up on the objective altogether
These are tough decisions, but one of them has to be made.
Conversely, if you need only a return of 3% per annum to achieve your objective, but you happen to be very tolerant to risk, it does not follow that you should automatically put in place a higher risk strategy. If the risk of a poor outcome would leave you in an unacceptable position, we should question if you have capacity to take on the risk, even if you are apparently tolerant of it, and some balance should be found.
It’s okay to leave your capital in a cash deposit account generating a low return, if there is sufficient money to achieve your goals and the fear of capital losses is greater than the desire for long term real returns. Not everyone will agree with this, but that’s the point. What’s right for everyone else, is not necessarily right for you.
You can see that the start of this process is a clear understanding of what you want to achieve, and this is the financial planning process. It requires some thought on your part and clarity about where you want to end up. It also involves some work on our part to show you what you need to do to get there.
The need for better communication between adviser and investor
Most situations allow for trade off decisions to be considered and this is where the value of financial planning advice is demonstrated. The role of a financial planner is to help you understand the issues, in order that you can make an informed decision. You must make the final decision because you will have to live with the consequences.
Risk cannot be avoided and in fact it is often to be welcomed – but it should be better understood and can be managed. In my view, this should only be considered after you have a clear plan in place. How else can you determine what your capacity for risk is?
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Free advice is never free
Have you seen an advert for “free” financial advice? Some financial advisers market their advice as “free” but there is a cost somewhere along the line, and often it’s at the point of signing up to a financial product. The concept is that advice is free but the product is not. For me, that’s the wrong way round. This article is not having a pop at those advisers that choose to have a transactional ‘commission for sale of a product’ model… that’s for another blog!
No, today I want to make a point about something much worse, but on the same theme. There is an advert on the tv for free, clear, independent and unbiased financial advice. Sounds good. Where is it from? Well, its actually an advert created by our regulator – The Financial Services Authority – for its Money Advice Service which purports to give free, clear, independent and unbiased financial advice. Why then, would you need to speak to a financial adviser or financial planner and pay for financial advice, when it is available for free? The answer is because you are not receiving advice.
One of the requirements for being a financial adviser or planner, regulated by the FSA, is that we are accountable to our clients for the advice that we give, and if it is in some way found to be unsuitable, we are open to complaints and a compensatory process. Actually, that’s not quite right, we are regulated on the advice we give on regulated products – that’s pensions, investments, life assurance, mortgages etc. not planning advice. The FSA does not currently regulate advice where there is no product. If an individual is disadvantaged through this Money Advice Service, will there be an opportunity for recompense? No, because it cannot offer regulated advice. The site and the ‘advisers’ will not recommend financial products. No for that, you must make your own decision or speak to a regulated financial adviser/planner.
The Money Advice Service website acknowledges that for 2011/12 it has a budget of £43.7 million to put toward advising the population. Where did it get the money? As a levy on regulated financial adviser firms.
So, let me get this straight, the FSA extracts a chunk of money from financial advisory companies, which we have no choice but to pay, in order that it can create an information service that, on the face of it, appears to compete with financial advisers. Not only that, but it declares to be providing something it is clearly not. I think the advert is completely misleading. Any regulated financial advisory firm doing this would be met with enforcement action. Talk about double standards, and with our own money too! Come to think of it, this so-called advice cannot be free can it? It is the clients of regulated financial advisory firms that are paying for it through the fees that financial advisers charge to meet their business costs – one of which is FSA regulatory fees and levies. So there you go, the clients of financial advisory firms not only pay for their own advice now, but according to the FSA, also for the masses to receive clear, independent, unbiased advice too.
I’ve been on the website and I went through the financial health check questions. It took about 5 minutes and I got a 42 page report in about 20 seconds. If you’re interested, I attach the report here for you to see. Don’t bother! I’ll tell you what it says. “Understand your budget, and think about how this fits into your life, and how it would fit into changes in your life caused by death, disability and retirement. Have a look at some tools that we provide (the budget planner is mentioned on almost every page) and if you want to buy regulated products, or need advice, speak to a regulated financial adviser/planner.
The website has some useful tools including some product comparison tools, but frankly this doesn’t answer the question that most people have, which is “What should I DO?” And that is why financial advisers are accountable for their advice – which is definitely not free!
Look, I’m all for financial education of the population. I don’t have a problem with making a contribution to the funding of it either, but I do object to the misleading message that the UK population can get good quality, independent, unbiased financial advice for free, with no accountability. This is undoing all the good work done by so many people to explain the value of what proper financial planning is all about.
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Stock market falls cut pension values
An article appeared in the FT today, which suggests that pension investors are in for a poorer retirement. According to the FT, the combined effect of falling equity markets and falls in annuity rates is worth together about 18% less in the space of one month. I’m not going to argue with the numbers, but my question is “Do pension investors who expect to buy annuities in order to secure their retirement income, stay fully invested in equities right up to the point of drawing benefits?”
This is a dangerous strategy since any fall in the equity markets could have a catastrophic effect on your lifetime income. In addition, the act of purchasing an annuity means transferring the risk of providing a lifetime income to an insurance company, and in doing so, crystallising the value of the pension fund on the day of annuity purchase. If you are unlucky enough to experience a fall in equity markets just as you retire, then this could mean a dramatically lower pension for the rest of your life.
The article suggests that pension investors have not given any thought to the way that pension benefits will be drawn, BEFORE the event, which means there has been no planning. It goes on to make reference to adopting pension drawdown as a short term option whilst waiting for equity prices to recover, which would be a short term knee-jerk reaction based upon the circumstances of the day. If you found yourself in this position, then perhaps you might make this choice but this is not a situation to relish and it is preventable.
In my world, financial planning would involve a discussion between client and financial planner well before the event of drawing pension benefits – probably at least five years beforehand. Within a financial plan, a lifetime cash flow forecast would identify the amount of money needed for retirement income and this would drive the investment decisions to be followed in the run up to retirement, the intended date of drawing benefits and the way in which benefits would be drawn (annuity purchase or pension drawdown being the two main options).
This planning gives clarity to the actions that would be followed and the reasons behind them.
If you are expecting to draw your pension fund benefits in the form of an annuity, then a decent financial planner will not be recommending that your investment strategy is held 100% in equities right up until the point of purchasing an annuity. Most likely, the strategy would involve a more cautious approach, to protect against exactly the circumstances highlighted in the article. Investment in fixed interest securities in the run up to drawing benefits will offer lower risk of loss than equities, and will also act as a hedge against falling annuity rates.
The key to making good decisions is to be prepared well before the event, and this means engaging a Certified Financial Planner to help you design a strategy. This way, you will be clear about what you are doing and why and you are less likely to be faced with last minute reaction to events beyond your control.
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Financial Planning – like a round of golf?
It is often said that if you fail to plan, you are planning to fail. That’s a bit cheesy, but it’s rare that we end up at the right destination without a map of some description, especially if we are not quite sure where we are going, and (if we are men) we are not inclined to ask for directions! At best, it takes us longer to get there, and at worst, we end up somewhere we didn’t intend to be.
As a golfer, I understand the benefits of a planned approach to a round of golf. A yardage book will help me plan the strategy and avoid unnecessary risks that I might encounter during the round. A good caddie is also of great value in helping to plot the course and keep me on track, perhaps with well timed words of caution or encouragement where necessary.
Is it a coincidence that the best golfers in the world plan every round of golf they play? And when interviewed after a good round say, “I stuck to the game plan”. And is it any coincidence that weekend golfers without a plan (or a caddie) make mistakes and never fulfill their real potential?
And so it is with financial planning. Without a strategy, it is easy to be distracted by the ‘noise’ of the media, friends and relatives who offer well meaning (but unqualified) advice, and the internal chatter of our own minds as we struggle with our fears and preconceived beliefs.
A financial plan is the equivalent of a yardage book, with optimal strategies to follow and unnecessary risks to avoid. Think of a financial planner as a financial caddie, someone who is there to listen, help create the strategy, measure all the changing variables, keep you doing the right things and to offer words of warning or encouragement at the right time.
Like a round of golf, life doesn’t always go to plan! The strategy needs to be sufficiently flexible to be able to cope with unexpected outcomes. When you hit the ball in the trees, plan ‘A’ for that hole is often set aside and plan ‘B’ becomes plan ‘A’. A frequent review of ‘where you are on the course’ is sensible in order to play your best and shoot the lowest score you can.
Transcend Wealth Ltd offers its clients an ongoing financial planning service, which seeks to lay out the strategy to be followed to achieve your desired lifestyle. We monitor progress, adjusting the plan as time goes by and events change the landscape.
We also really enjoy playing golf.