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. Make Sure You’re in the Right Wrap
A wrap account provides the ability to review and manage all your investments in one place – and many advisers recommend them. While wraps have some fantastic benefits (such as the ability to rebalance or allocate new funds automatically), unless you are using them properly, the consolidated management and reporting is often most helpful to your financial planner and accountant.
Wrap accounts can be expensive. But the good news is that costs are coming down due to competition and the popularity of wraps. Some offer family or group discounts, where multiple wrap balances can be grouped before the tiered fees are applied (you may have multiple wraps, your partner and even your kids/parents wraps can be grouped in some cases).
So, make sure you’re getting the most out of your wrap and review the costs against other options.
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, even industry funds.
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 can’t through other options (eg the ability to buy direct property). 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 types of 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. I’ve met many people who have an unused SMSF from a now defunct plan to buy property.
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 much less.
4. Beware the Additional Costs of ‘In-House’ Services
Many financial planning firms attempt to manage as much of your financial planning requirements as they can.
And there can be benefits to the one-stop financial advice shop model, such as convenience.
But, you can end up spending a lot of money where your adviser’s strategy requires the use of additional in-house services. A common example is the recommendation and management of a SMSF – which will often incur costs through a mortgage (and possibly an expensive off-the-plan property), investment advice, auditing and accounting services.
A ‘one-stop shop’ mostly benefits the advice firm or bank. Anytime you hear a mortgage broker 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).
Independent financial 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 by hundreds of 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 many cases, the new strategy stood to pay thousands of extra dollars to the planner and often 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, inflates the costs of your financial products.
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. Many insurance advisers do this because people tend to focus on first year costs only.
Always use a financial adviser who will discuss and compare the costs of your financial strategy for the life of the products they are recommending to you.
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 25% 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.
And, your financial plan will suit your changing circumstances.
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: