1. Consider the Costs of an Active v Passive Portfolio
The more active the investment strategy you implement, the more it will cost.
Most financial planners recommend actively managed portfolios or active funds that perform worse than a passive portfolio or index funds. And an active portfolio costs more, as well as possibly performing worse.
A passive strategy might involve holding onto better quality investments over the long term. It might involve index funds, listed investment companies or exchange traded funds.
In the case of actively managed funds, the majority of these underperform the market index (and remember: they cost more). Can your financial planner pick the good ones? History tells us that most cannot.
And what are you paying your planner to attempt to pick next year’s high performing funds? In addition to higher investment management costs within the managed funds themselves, you will often find your planner has added advice fees to your portfolio so they can monitor these active funds. They do this due to the potential for a high level of deviation away from the average market return. In other words, your adviser has to get rid of the duds quickly, so they don’t affect your overall return too much.
Unless you have enough money to justify paying someone to manage your portfolio, you will most likely find that you will get a better return in a passive portfolio. And you will pay less.
Fees have a huge impact on your wealth, so make sure you are getting a return that justifies the costs of managing your portfolio.
2. Consider Alternatives to Expensive Wrap Accounts
A Wrap Account provides the ability to review and manage all your investments in one place – and many advisers recommend Wraps. This consolidated management and reporting is most helpful to your financial planner and accountant, especially if they are managing a SMSF.
However, many Wraps will cost you around 0.5% of your portfolio. If you have $500,000 invested, you will pay $2,500 p.a. for the benefits of consolidated reporting and one place to trade stocks and buy managed funds.
There are other options that charge a fixed fee at a fraction of the cost of a traditional wrap. These reporting systems allow you to feed data from your various investment, bank and brokerage accounts. They provide consolidated reporting for the purposes of accounting and auditing a SMSF or simply providing you with an overall view of your investments.
Even Wraps themselves can vary greatly in cost. If you want the benefits of having access to all your investments in one place, then make sure you don’t pay more than 0.3-0.4%. As some Wraps have a capped ongoing fee, if you have a large enough balance (about $2,000,000), the ongoing cost can be justified if you gain access to wholesale funds that suit your investment strategy.
Many people find they are perfectly happy managing their investments directly. This may require more management from you or your adviser, and your adviser may charge you more for this work. But in all likelihood, it will cost less than 0.5% of your portfolio.
Regardless, you should scrutinise the costs of any super or investment administration platform. And, make sure you are getting value for that cost – and not just making your financial planner or accountant’s life easier.
3. Do You Really Need a SMSF?
Many people set up a Self-Managed Superannuation Fund for the extra control. But in reality, most of those people can get the same control through other less expensive platforms.
The costs of running a SMSF has come down considerably. But so have other platforms.
And SMSFs are a big commitment – both legally and time wise. Only use a SMSF if you are accessing benefits you cant through other options. For example, many public or retail super funds now offer access to shares, ETFs and even gearing – and many people only use their SMSF to invest in these investments.
If you plan on using your SMSF to take advantage of a benefit you cant through a traditional super fund, then only set up the SMSF when you need it. Aside from the administrative headaches, a SMSF can cost $1,000s p.a. more than other super funds.
In my experience, too many people set up a SMSF and don’t know what to do with it. Then, they use it to access the same benefits available in a public fund that costs a quarter as much.
4. Beware the Additional Costs of ‘In-House’ Services
Many financial planning groups, especially banks, charge a set fee to manage as much of your financial planning requirements as they can.
For example, this might include the management of your SMSF – which will likely cover ongoing investment advice, reviews, auditing and accounting services.
You can often save money of you break these costs down and use one financial planner to manage each advice specialist.
A ‘one-stop shop’ mostly benefits the advice company or bank, as they build in additional costs you don’t need to pay. Anytime you hear a financial adviser tell you something like “we will do your insurance for free, if you get your loan through us”, alarm bells should ring. The insurance may not incur any upfront costs, but will be loaded with commission, which inflates the costs to you. Banks, in particular, use this approach.
Advisers whose businesses are aligned or owned by large financial groups also tend to recommend in house super, insurance and investments (check your adviser’s Financial Services Guide to see who owns the license they practice under).
Non-aligned advisers spend their time scrutinising every option in the market place.
5. Check Your Financial Planner Doesn’t Gain More From Their Advice Than You Do
I have been contacted my many people who have questioned the benefits in their financial planner’s advice (if you don’t clearly see the benefits, that’s a problem to begin with). Most of these people have an ongoing relationship with a planner who has recommended a new strategy, such as a SMSF or new investment platform.
In every case presented to me so far, the new strategy has paid thousands of extra dollars to the planner, with very little (if any) additional benefit to the client.
The lure of additional fees a financial planning company can make from a SMSF or a new way of managing your investments directly, can result in advice that creates additional risk and, in the case of a SMSF, greater administrative burden for you.
6. Consider the Costs of Your Financial Plan Beyond Year One
Ongoing trailing commission very quickly exceeds the costs of upfront commission. For example, your mortgage broker makes tens of thousands of dollars more over the life of your loan than they do when they arrange your mortgage. This provides a huge incentive for advisers to recommend one product over another. And adds to the costs of your mortgage, insurance, super and investments.
One of the biggest risks to you getting the best insurance advice, is that many advisers will compare the costs of different insurance products in the first year only. But prices can change drastically after a few years. Insurance advisers do this because people tend to focus on first year costs only.
Always use a financial planner who will discuss and compare the costs of your financial strategy for the life of the products they are recommending to you.
If you are getting mortgage advice, his should also include the exit costs of paying out your loan and refinancing down the track.
7. Don’t Pay Full Price for Insurance Without Considering a Fee For Advice
Few advisers will tell you this: insurance costs can be reduced by as much as 32% p.a. if the commission is removed from the products at implementation.
Your adviser still has to be paid for their advice and for arranging the insurance. However, it might be more cost effective for you to cover this cost with a one-off upfront fee (sometimes able to be taken from your super). The cost of this fee can often be covered within a few years, saving you thousands over the life of your insurance.
8. Consider ‘Level’ Insurance Premiums
A ‘level’ insurance premium is designed to stay the same throughout the life of your insurance. But level premiums start out more expensive.
The most commonly recommended type of premium is called ‘stepped’. It is linked to your age and designed to increase, as you get older. These stepped premiums become exponentially more costly and are prohibitively expensive after a certain age – usually in your 50s.
Which premium type suits you, depends on your circumstances (health, age, duration you need cover, etc).
The cumulative costs of both premiums types must be compared.
Be aware that stepped premiums are recommended by most advisers, as they are much cheaper in year one. And initial costs are where most people focus.
Make sure you consider each premium type and look at the costs over the life of your insurance. It could save you thousands.
9. Ensure Your Financial Planner Uses Any Existing Trailing Commission to Cover the Costs of Ongoing Advice
Trailing commission can be avoided. But, you may have an insurance policy that already has trailing commission built into the premiums. Or, you may choose to cover the costs of your advice through upfront commission, rather than a one-off fee.
Ether way, make sure your financial planner discusses the options for refunding commission, or avoiding it altogether. If an upfront commission is paid to your adviser, make sure they use this to cover initial advice costs.
Any ongoing commission received by your adviser should be used towards the costs of ongoing service, such as a regular review. Ideally, a specific ongoing service arrangement should be agreed with a set fee – and a refund of any ongoing commission.
10. Review Your Ongoing Advice Fee Every Year
If you pay an ongoing advice fee that is automatically deducted from your investments, you can end up paying more for advice than you should. As your needs can change, you should agree to an ongoing advice fee at the beginning of each year (or anniversary of your initial advice). This will help ensure your financial planner remains motivated to provide valuable ongoing service and that they don’t become complacent.
11. Ensure You Have Regular Contact With Your Financial Planner if You Pay an Ongoing Advice Fee
Many financial planners will justify the bulk of their ongoing fees by explaining that you get “access to a financial adviser”. Your adviser may claim they are constantly monitoring your portfolio, ready to call you if market or economic conditions trigger a need for change. Some advisers do this (and you will pay for it). But more often than not, your portfolio will only be reviewed at your regular review meeting.
Ask for a breakdown of the exact service your ongoing fees cover. If you are essentially only paying for a regular review, ask that you only pay for your review when you have it. Financial planners who follow best practice will set all ongoing advice costs at the anniversary of your original advice – and base fees for the next 12 months on your ongoing (and changing) needs.
12. Make Sure You Get Your Reviews at the Agreed Intervals
Many financial planners fail to provide their ongoing reviews consistently, at the agreed time interval. In my experience reviewing financial planners practices, most provide their annual reviews every 13-14 months. This usually happens because either the financial planner gets behind or they don’t call you to arrange your appointment until the review is due, and people are often not available for a few weeks.
A review does not constitute your entire ongoing service, but it forms a big part of the cost.
If you get your annual review every 14 months, then you will only get 4 reviews over 5 years. And, as you have paid for 5 reviews, your financial planner is short changing you by an entire meeting.
This gets worse with 6 monthly reviews, where I have often seen reviews taking place at 8-9 month intervals.
In addition to overpaying, you might miss out on important updates to your financial plan.
(I know a retired couple whose previous planner failed to provide their review, just before the GFC in 2008. They missed an opportunity to tell their planner they felt they were invested too aggressively, a concern that was documented in the planners file notes after a call the clients made early in the year. They estimate they lost $90,000.)
Contact me (or enter your details below) if you want to talk about your situation.
And, watch this video from the ABC’s The Checkout, just to lighten the mood: