Reason 1: Overheads
Nobody provides advice for free. All advisers charge a fee for advice – either indirectly through commissions or directly by stating the fee upfront. It is impossible for any advisory firm to provide free advice. The fee you pay – either in commission or agreed fee is meant to help offset the large amount of overhead as illustrated below (Note: not drawn to scale):
There are generally two types of overheads: Direct and indirect expenses. Direct expenses are like utility bills, salary of administrative staff, IT support, licensing fee, professional indemnity, advertisement and rental. Indirect expenses are those which incur opportunity cost due to the long hours spent on it. Examples of indirect expenses will be CPD hours, product launch attendance and research. The time spent on these mean less time to meet clients and thus the lost of income. For other matters like professional courses and conferences incur both direct and indirect expenses.
Reason 2: Commission is an unfair method of remuneration
This is because:
- A client who buys the product (which pays the commission) is subsidizing another who does not buy;
- Some products pay outrageous commissions for little work done. This is unfair to the client afterall the client is the one who ultimately pays the commission.
- Some products pay insignificant commissions despite the large amount of work that the adviser has to do. Thus, the adviser is under paid;
- Many superior products pay no commission and thus advisers have no incentive to recommend these if they are relying on commissions;
- Many important areas of financial planning do not require purchase of product. Advisers will not be paid for helping clients plan for these areas.
Areas in financial planning that do not require purchase of products are:
- Minimizing income tax;
- Debt management;
- Cash flow, Balance Sheet and Ratio Analysis;
- Advice on the selection of employer sponsored insurance;
- Investment planning using passive funds like ETFs;
- Mortgage loan and installment calculation;
- CPF related advice such as amount eligible for mortgage, Minimum Sum Scheme, CPF Life, etc;
- Removing duplicate insurance policies;
Reason 3: Fee-based financial planning or fee for advice is the fairest way of remuneration
This is because:
- Transparency – you know how much you are paying;
- All clients pay according to the actual work done. A simple case cost less than a complex case. No cross-subsidy;
- Advisers are free to recommend without worrying about their compensation since this is already decided upfront;
- Superior products with no commission payable will be considered by the adviser;
Reason 4: Commission-based adviser may not put your interest first
This is because:
- The adviser has no incentive to spent time on matters that will not result in a product sale. Clients will not necessarily get the most wholistic advice;
- In the table below, it shows that commission-based adviser will push the client from Stage A to Stage B of the advisory process. That is to say that such an adviser will tend to push the client to purchase some products. On the other hand, a fee-based adviser will not push the client from Stage A to Stage B.
- The commission-based adviser focuses on product sale (since he is paid for sales) while a fee-based adviser focuses on the quality of his advice (since he is paid for advice).
Which do you prefer? A salesman or an adviser?
2. Fact finding
|Nothing paid here||Majority of the fee earned here|
|B||5. Implementation/ product purchases||Majority of the commissions paid here||Minority of the fee earned here|
|C||6. On-going review||Commissions repeatedly paid herefor sales of unnecessary products||Fees earned here for providing on-going service|
Reason 5: Moral hazard
Imagine a doctor who cannot charge a consultation fee but could only earn through commissions selling medicine. Can you imagine the health hazard of being prescribed unnecessary drugs just because the doctor could only earn through commissions selling drugs? Similarly, the financial hazard of engaging a commission-based adviser could put your family and your retirement in jeopardy.
A financial planner is a financial doctor. Only a person who is financially unwell is required to consult a financial planner. Others who are well would consult a financial planner to avoid future financial trouble through "preventing" advice.
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