Independence is often touted as a significant advantage in financial planning because clients have some reassurance that their financial planner is providing advice untainted by commissions or sales incentives. There is also an argument that one product provider cannot be the best solution for all problems. Unfortunately, independence from a product provider does not guarantee ethical behaviour. It would be naïve to think all independent financial planners are virtuous souls, but they are arguably better than the average tied agent.
As a co-founder of an independent financial planning firm, I am biased toward independent firms. However, I wonder if they are becoming extinct. Independents are slowly drowning under increased regulatory compliance costs, decreasing fees and increasing administrative ineptitude from product providers. Many industry bodies and regulators pay lip service to the merits of independent financial planning, but their actions indicate a lack of will to help them survive.
Why are non-independents problematic?
Let’s start with some plain language. While we know what independent financial planners are, there seems to be no consensus description of businesses that are the opposite. When I asked some industry experts for the correct terminology for these businesses, I received the following replies:
- Corporate financial planning business
- Vertically integrated
- Tied
- Institutionally owned
- Institutional
- Corporately owned
- Non-independent
For the sake of this article, I will refer to them as Corporates. These are businesses that are both product providers and financial planners. Some Corporates only allow their financial planners to sell the firm’s products. Other Corporates allow their financial planners to sell a range of products, but there are incentives to use the firm’s products. In both cases, I believe (I can’t confirm) that these firms generally pay commissions (based on “production”) or have revenue-sharing arrangements with their financial planners. In other words, they don’t pay professional salaries like an accounting firm would pay its professionals.
Very often, these revenue-sharing or commission payments are very lucrative for financial planners because the product provider earns fees at every level. This includes administration, fund fees, advice fees, performance fees (in some instances) and possibly other fees. It is not unusual for these fees to amount to more than 3.5% per year. If the products offer a capital guarantee or have a fixed term, the fees might be much higher and paid upfront.
Suppose you have a greater financial incentive to sell products offered by your employer rather than third-party products. There is the potential for you to compromise your advice standards in favour of becoming a product pusher. It might surprise you that even though there are great incentives for becoming a product pusher, some ethical people continue to work at Corporates while offering the best advice. Very often, they end up using lower-cost third-party products to the displeasure of their managers, but they maintain their ethics and advise their clients appropriately.
Consider the massive growth of firms that have aggregated large numbers of financial planners over the years. Initially, these businesses bought lots of planning firms around the country and allowed them the freedom to continue operating as usual. However, it is clear from the growth in assets of these firms’ unit trust companies that the financial planners started to switch clients from third-party asset managers to their new bosses’ funds. One must wonder if the third-party funds were always worse for clients or if incentives played a role in this process. Are all these clients better off now in a product-owning financial planning business?
Small business are either drowning under the cost of compliance or not complying with every regulation.
Is bigger better for the regulators?
When we review the impact of increased regulation on the financial planning industry, it seems that the regulations favour larger businesses. Small businesses are either drowning under the cost of compliance or not complying with every regulation. To comply with all the compliance regulations, companies must invest in expensive systems and compliance staff and spend a lot of time staying current with regulations often aimed at Corporates.
The risks of non-compliance for small businesses are much higher than for a Corporate. When a Corporate falls foul of the regulators, it pays a fine and carries on. A fine could end the business if regulators find non-compliance in a small business.
What of the future?
It might be better for smaller independent financial planners to give up on the dream of running a small independent financial planning practice. Continued survival in the industry might require you to:
- Join the race to get bigger as quickly as possible.
- Sell out to a Corporate.
- Join a network of independents where you can share some resources to reduce your costs.
- Find a new form of consolidation that encourages the best advice without ethical compromise.
From personal experience, I know that the fund managers and DFMs who generate significant revenue from independent financial planners are worried about the future of independent financial planners. Still, they are unwilling to help sustain independents in any meaningful way. Most of them offer excellent workshops, lots of networking opportunities and exposure to global experts. But please don’t ask them to use their financial muscle to underwrite funding for financial planners who want to buy other businesses or for founders to sell their firms to their staff.
The regulators are pushing for more transformation in the financial planning industry. If regulators really want to push transformation in independent financial planning, they should create a mechanism where staff can access funding at reasonable interest rates to buy out the founders at slightly discounted prices. Banks, insurers and large fund managers have the capital to underwrite this; they are just not doing it. If the regulators added some motivation, I think we will transform the industry and maintain independent financial planners long into the future.
