David French | 18/02/2009 1:06:42 PM

This article was originally published by The Morning Bulletin in June 2005

A seminar attendee recently claimed that financial planners should not charge any up-front fees, but should be rewarded according to the returns they generate. Other people say advisors should not charge ongoing fees, but rather a series of one-off fees, much like a doctor.

Before selecting a Financial Planner, it is important that you have a good understanding of their fees. These are usually detailed in their Financial Services Guide. This article will help you to understand the fees that you are likely to be charged by your Financial Planner.

Generally speaking clients’ either pay directly for financial advice and ongoing assistance, or they pay commissions (upfront and ongoing), a portion of which are passed back to the advisor.

Up front fees help defray the cost of getting clients’ affairs in order. Providing advice on setting up a self-managed superannuation fund, a trust or a company, or restructuring a portfolio is a one-off task that can yield huge ongoing value to a client. It can also be very time consuming. Without any prospect of ongoing fees, up front fees may have to be very high - a problem that many accounting practices struggle with.

Ongoing fees cover maintenance of clients’ affairs, commonly portfolio management, superannuation issues, tax issues, Centrelink, and deaths. These services can be very valuable for to the client, but charging on an ad-hoc basis may not be economic $3,000 for a simple Centrelink investigation, according to one bill we saw. By treating the work as part of managing a client’s ongoing affairs, the client can expect ongoing attention and often lower ancilliary costs - brokerage and interest for example. From the financial planner’s point of view, a known revenue stream underpins the operation of the business in both good and bad times, providing incentive to deal with difficult matters and to take a longer-term view.

Contrast this with the traditional stockbroking model, which charges brokerage on each trade. To earn a living, a broker has to do a lot of trades, and this might not always be in clients’ interests. Worse, in weak markets advisors are laid off, just when clients most need the advice. There is also no incentive to investigate capital gains tax issues, or peripheral but important matters. It’s no coincidence that many stockbroking firms now offer portfolio management services.

Finally the argument that advisors should be remunerated on the basis of excess returns alone has significant problems - in particular how do we measure excess returns? In the period to March 2003, we outperformed the index by around 25 percentage points (the market fell by about 18 per cent), and based on commonly used measures could have charged a performance fee of around 6.25 per cent. That would have put a lot of money in our pockets, but would have put client’s net returns in negative territory. Not only that, one year’s fee would have covered 3 years of ongoing fees in an expensive managed fund, and 5 years of management fees in a cheaper management structure. The scope of performance fees is narrow, and in the end clients pay.

The Investment Collective (AFSL 471728) is a non-aligned financial planning and investment firm specialising in providing tailored financial and investment advice for individuals and small business. Capricorn Investment Partners Limited's services include financial planning, share trading, portfolio management, insurance broking and self managed super fund administration. Additional information on services provided by The Investment Collective Limited can be found by following this link. Readers are reminded that this document has been prepared for general information purposes only, and any advice contained herein has been prepared without taking into account your financial objectives, situation or needs. Readers are advised to see their financial advisor prior to acting on any general advice.

More articles about fees.

Related articles and other links:

• Development and implementation of a Financial Plan
• Understanding Fees