This article will be deeply unpopular amongst financial advisers. For those advisers reading this, please attempt to see this from a client’s perspective and not someone whose livelihood depends on maintaining the status quo. It will always be difficult to read critique of a core business practice. However, if ours is to become a profession, dissent will be necessary for its progression, especially in the eyes of the general public.
The reality is that most Australians have never sought financial advice. If we assume advice is always a net financial benefit, this shouldn’t be the case. Many would attribute the low uptake to high costs or lingering distrust from past industry failings.
This article will make the argument that many more would seek advice services if one critical pillar of the industry weren’t so common. This, of course, is the ongoing advice fee model.
Charging clients on an annual basis is the foundation of nearly every financial advice practice. It’s also the primary way these businesses are valued when bought and sold. But what are the consequences of this model? And why will it eventually limit the uptake of financial advice?
Initial Fee Inconsistency
Let’s start by examining a clear inconsistency in how most financial advice firms structure their fees.
For the average firm, initial fees typically range from $3,000 to $7,000. While higher fees exist, they are relatively rare for the typical client. The inconsistency becomes apparent when we compare these to ongoing advice fees.
The image below is directly from the FAAA website:
The fact that the average ongoing advice fee is higher than the initial fee doesn’t really make sense. Most advisers would agree that onboarding a new client is the most time-intensive part of the advice process. Multiple meetings, Statement of Advice (SOA) preparation, and the extensive implementation of recommendations all contribute to this workload. It’s also the stage where clients receive the most immediate value, gaining a comprehensive review of their financial situation and having key changes implemented to put them on a better path.
By contrast, ongoing advice requires significantly less work. While some years may involve major changes that necessitate additional attention, these are the exception rather than the norm. This is especially so for retirees, where financial circumstances tend to be more stable.
So why do initial fees tend to be lower than ongoing fees? If initial onboarding is more time-consuming and delivers more upfront value, the pricing should logically reflect that.
The answer lies in the business model. Initial fees are often used as a loss leader, a discounted entry point designed to transition clients into a long-term, ongoing fee arrangement. These ongoing fees are not only more profitable but also form the basis for valuing financial advice firms.
This pricing structure creates a clear conflict of interest. By discounting initial services to secure a more lucrative long-term arrangement, firms shift their focus from providing standalone value to maximising client retention and recurring revenue.
Adverse Incentives
This section will likely provoke strong reactions from advisers, as it challenges the notion that their advice always aligns with the best possible outcome for their clients. However, acting upon conflicts of interest is not always deliberate. In many cases, they go unnoticed, especially when industry norms are ingrained from the moment an adviser enters the industry.
Charlie Munger summarised conflicts of interest perfectly when he said:
“Show me the incentive and I’ll show you the outcome”
As established earlier, ongoing advice fees are the primary profit driver for a financial advice practice. So therefore, logic would dictate that any reasonable adviser would act in a way that maximises this outcome, whether consciously or not.
This raises a crucial question:
Is it better for a financial adviser to empower their clients to manage their finances themselves, or to do the opposite?
An impartial observer would likely say the first option is best for the client. A pragmatic adviser, however, might quietly disagree.
After all, if every client becomes fully self-sufficient, who would still need a financial adviser?
Complexity for Complexity’s Sake
If an adviser’s goal is to maximise ongoing fees, and empowering clients to manage their own finances conflicts with that goal, what does the advice outcome actually look like?
The answer: complexity. Often, unnecessary complexity.
Two of the clearest examples are the continued reliance on wrap platforms and actively managed investment portfolios.
Actively Managed Portfolios
How much more data is needed to confirm that active management is, more often than not, a drag on client returns rather than a benefit?
Any good adviser surely understands this already. Yet, active management continues to be the choice for most client portfolios. Some portfolios may include the odd index fund, but the industry is still primarily active.
Why would this be so? Again, if it detriments clients returns, why would any adviser continue their use.
One explanation ties back to the adverse incentives discussed earlier. A complex portfolio is far easier to justify as needing ongoing oversight.
Financial advisers deal primarily with relatively financially uninterested individuals who may not immediately understand the difference between passive and active management. It is therefore very easy to overplay the importance of individual manager selection and the adviser’s role in that, especially to an uninformed audience.
By contrast, a passive portfolio requires minimal ongoing management. Ironically, this approach has historically also maximised long-term returns. But a low-maintenance portfolio is difficult to justify when charging thousands of dollars per year in fees.
Perhaps this explains why some advisers continue to resist passive investing, despite overwhelming research in its favour.
Wrap Platforms
Wrap platforms are essential for implementing active management strategies and, conveniently, for facilitating ongoing advice fees directly from a client’s portfolio. They allow advisers to monitor accounts and make portfolio changes across both superannuation and ordinary investment.
But beyond that, do they actually benefit the client?
If wrap platforms weren’t necessary for maintaining an adviser’s fee structure, would they still be widely recommended?
Consider cost:
- A low-cost industry super fund using index investments is often far cheaper.
- In some cases, even a Self-Managed Super Fund (SMSF) can be more cost-effective.
- A simple ETF portfolio through a discount broker is magnitudes cheaper than a wrap account.
An adviser who does not charge ongoing fees and follows a passive investment philosophy would have little reason to regularly recommend a wrap platform, especially for superannuation.
But wrap platforms enable ongoing fees. And it’s far harder to justify an ongoing advice fee if the best recommendation is for the client to stay put in their low-cost industry super fund.
Complexity Contributes to Unprofitability
This push for complexity also helps explain why initial fees are so unprofitable. The more accounts that need to be opened and the more convoluted the portfolio, the more work required to justify it.
Imagine the wordplay needed to move someone out of their industry super fund into a high fee, actively managed wrap account. In order to protect themselves against litigation, a firm needs to spend an inordinate amount of time making sure their disclosures are correct, the innumerable forms required to sign are generated and the client is adequately convinced that active really is better than passive management.
The financial advice process is a cycle that contributes to the unaffordability of advice, it is not just regulatory burden to blame. The justification of ongoing fees to clients necessitates complexity, this in turn causes upfront fees to be unprofitable, but this is justified because ongoing fees remain the real profit driver.
Calculating the Value of Advice
An ongoing relationship with a good financial adviser is undoubtedly a positive experience for a client. This article is not suggesting otherwise. Rather, the issue lies in how advice is priced, and the resulting conflict, not in its inherent value.
Ongoing advice fees often have little correlation with the actual time spent working for a client in any given year. Many benefits of advice are intangible (such as peace of mind), so the pricing isn’t truly value-based either.
Despite the shift toward so-called flat fees, the primary determinant of advice costs remains the amount of money managed on behalf of the client – commonly referred to as funds under management (FUM). Even most independent advisers structure their fees based on a client’s wealth, whether or not the percentage-based model is explicitly used.
Paying for the Possibility of Service
Annual advice fees typically entitle clients to a set number of meetings per year, as outlined in their ongoing service agreement. While this is an improvement over past practices, where no services were required to justify fees, it still raises a question. Do a few meetings per year warrant a fee that can climb into the five figures? Most impartial observers would say no.
The way services are provided by advisers to their ongoing clients can be likened to the insurance industry. You pay these high fees in case you have something come up that requires a large amount of advice. Some clients may need so much advice in a given year that, on an individual basis, it would be uneconomical for the firm. However, the fees paid by others who require less service ensure that aggregate profitability remains.
Given that there is very little link between fees paid and service rendered, the situation is this: higher paying clients effectively subsidise lower paying clients that may need more service. The clients at both ends of this spectrum would likely not be too thrilled to learn of this system.
The Weak Justification for FUM-Based Fees
Many advisers justify FUM-based pricing by citing the perceived risk of dealing with wealthier clients. The argument goes: if an adviser makes an error, the financial consequences for a high-net-worth client are greater, warranting higher fees.
This reasoning is somewhat flawed. Every financial adviser is required to hold professional indemnity insurance to cover such risks. Furthermore, the risk itself may stem from the very structures advisers implement to justify ongoing fees. Active management strategies and wrap accounts, for example, require direct implementation, increasing the likelihood of costly trading errors. If advisers instead recommended simpler, more passive strategies, their exposure to risk would diminish significantly.
With that said, there will always be an increased risk of dealing with richer clients. But it is far too simple to claim that this scales perfectly with the amount of funds being managed for them.
Final Thoughts
To reiterate, this article does not argue that clients fail to benefit from an ongoing relationship with a financial adviser. Rather, it highlights that the current fee model is outdated and poorly aligned with the work actually being done. A FUM-based ongoing fee structure is a blunt tool for an industry that deals with a broad spectrum of client needs. It fails to account for differences in complexity, service requirements, and most importantly the actual time spent providing advice.
It would be naïve for advisers to assume that many clients, both existing and prospective, do not already recognise the issues with the ongoing advice fee system. Fees and services provided are clearly not linked to one another. A few years without substantial advice would make even the most loyal client question signing next year’s multi-thousand-dollar consent form. Again, this introduces the conflict of trying to seem busy to justify the fees.
The more informed the consumer, the less likely they are to seek financial advice. One only needs to spend a few hours on the reddit page r/ausfinance to plainly see the disdain towards standard advice practice. Many advisers would be quick to discount these opinions as the ramblings of the terminally online, yet this forum has nearly 700,000 members. Many of whom are much more financially educated than the average Australian. If the opinion of the informed is that something needs to change, advisers cannot sustainability disagree with the sentiment. Eventually the chickens will come home to roost.
As the general population becomes more financially literate, and investing gets simpler and more affordable, the advice industry must evolve. Otherwise, the clients of now will not be replaced by their more informed children.
For financial advice to transition into a true profession, it must address the conflicts of interest embedded in its fee structures. Ongoing fees, as they stand, create misaligned incentives that undermine the profession’s credibility. If the industry wants to be seen as a profession, it must be remunerated in a way that reflects professional standards. Prevailing sentiment among younger and more financially aware Australians makes this shift inevitable.
Whilst this business does not charge ongoing fees, it would be hypocritical not to acknowledge our own conflict. Every person and every business will have innate conflicts of interest. Humans are naturally self-serving, and incentives shape behaviour. However, it is the responsibility of industries and professionals to implement structures that constrain action to ensure that those we serve receive advice that is genuinely in their best interest.
