How do you choose a financial advisor?

How do you choose a financial advisor?

This is not an easy question to answer; choosing an advisor is a little like choosing a marriage partner (you might end up having a longer relationship with your advisor than your spouse!) and secondly, the financial advisory environment is in a state of flux.

Representatives and financial advisors

There are approximately 140 000 representatives registered on the FSB website and according to the latest Financial Services Board Annual Report, only 10 164 of these are Category 1 financial service providers, which means that they are authorised to give advice. (See table below). These advisors may charge their clients an advice fee and, depending on the contract with product providers and clients, may also receive a commission. Harbour Wealth readers should aim to select one of these 10 268 advisors as they are permitted and capable of offering independent advice.

The balance of 130 000 representatives generally work for an employer and sell a limited range of products provided by one company. Their advice is therefore partial; they are able to sell only the product range at hand, not those that might be more suitable for your needs. They are usually remunerated with commission-based structures.

Most insurance brokers or agents are ‘representatives’, as are most insurance agents in call centres. If you use the financial advisor at your local bank, it is likely that you would be dealing with a tied agent; someone who is only permitted to sell and advise on the bank’s products. Multi-tied agents are brokers who offer products from a limited panel of providers.

What are the licensing requirements for financial advisors?

An advisor has to have a Category 1 license in order to offer advice. There are 13 sub-categories within the Category 1 licenses, so an advisor that sells collective investment for example should have a category 1.14 license and an advisor that sells short term commercial insurance should have a 1.16 license. If you want to check the license categories of a particular advisor, all you have to do is visit the Financial Services Board website. Details are at the end of this article.

	Number	Range of advice
Category l	10 164	License holders permitted to provide advice and/or intermediary services on a non-discretionary basis. This means that clients must sign off on every product bought or invested in.
Category 11	585	License holders permitted to manage discretionary investment management services. This means that clients are not required to sign off every decision made by the investment professional.
Category 11 A	117	License holder permitted to manage a hedge fund.
Category 111	24	License holder permitted to administer investments
Category 1V	68	This is the category for assisted business service providers.

 

In addition to competency and knowledge based requirements, all financial advisors are required to be ‘fit and proper’ which means they have to be honest and upstanding. The regulator, the Financial Services Board is constantly aiming to improve the level of professionalism in the financial advice sector. Standards of compliance are being raised through a combination of FAIS compliance requirements, additional exams and new legislation.

It is essential to appoint a financial advisor who is registered with the Financial Services Board. To confirm that your advisor is licensed with the FSB you need either their business name or their FSP number. The visit the FSB website www.fsb.co.za and follow the prompts.

According to the FSB website, the FSB’s focus, according to the deputy registrar for insurance Jonathan Dixon, is to promote appropriate, affordable and fair advice and services. It is also to support a sustainable business model for financial advice – a business with annuity income through trail fees is more sustainable than one which relies on upfront commissions.

Recent industry trends

South African financial advisors work in a challenging industry. As mentioned above, they have to remain abreast of issues and are required to write new exams and comply with new legislation. Latest in the list of new requirements are the proposed Treating Customers Fairly (TCF) and Retail Distribution Review (RDR) policies; these policies have recently been enacted in the United Kingdom and Australia. Legislation governing TCF and RDR will be phased in here over the next 24 months and will require new levels of disclosure to clients as well as, in some cases, a fairly fundamental restructuring of business models. The purpose of the legislation is to make advisors more professional and more accountable to their clients, but it may also ensure that financial advice will no longer be available to lower income earners.

Compliance with TCF and RDR is expected to be fairly onerous and in the short term the new legislation may be the last straw for those financial advisors who consider themselves over-regulated. According to statistics in the public domain in the UK, the number of financial advisers in the UK has dwindled down from 35 000 in 2010 to around 20 000 following the introduction of RDR. The South African advice industry could face a similar fate.

But of course, where some see hurdles, others see opportunity. According to Eugene Maree, founder and CEO of Harbour Wealth, the company has been structured to be compliant with the new legislation and will help those financial advisors who choose to embrace the new legislation manage their clients easily and effectively.

‘The TCF requires advisors to treat all customers the same,’ he said. ‘Advisors are expected to sell their services to financially literate clients at the same rate as less astute clients. In the TCF environment, two clients with the same risk appetite should be in the same products. This is wonderful for us, because we are committed to the spirit of TCF and furthermore, our systems will be able to manage the requirements of treating customers the same’.

Maree explained that the main requirements of RDW will be that the advisors will be expected to negotiate all earnings with their clients.

‘All commissions, hourly rates etc will have to be discussed and agreed upon,’ he said. ‘An unfortunate consequence of this might be that clients at the bottom end of the income scale may not be able to afford the advice they need. In the past there was a cross subsidization from the wealthy to the lower income clients which will now fall way’.

A further challenge presented by RDR is that advisors will have to be familiar with the classification of advice between ‘independent’ and ‘restricted’ and tailor their businesses accordingly. Maree says that the Harbour Wealth and Wealthport platforms will be able to accommodate collective investments of the advisors’ choice.

‘Our business model will not be to channel volumes through particular funds,’ he said.

So where do you start?

Choosing a financial advisor is a very personal decision. Everybody has different requirements of an advisor; there is no ‘one advisor fits all’ solution.

After you have understood the difference between tied and independent advisors, and found out where you can check out if an advisor is registered, you should set about identifying a suitable candidate. A possible starting point is to use social and other media; listen to the radio, read newspaper reports and generally gather information about financial advisors that have won awards or are widely quoted. Ask your friends for recommendations. Use LinkedIn and Facebook to get a flavour of the advisor’s philosophy and special areas of interest.   Ask your friends for recommendations. When you meet a prospective advisor, ask him or her for references.

Qualifications /expertise/ remuneration / indemnity / minimum levels of investment / membership of industry bodies

Once you start narrowing down your selection you should consider the following factors:

• Qualifications , experience and areas of expertise
• Fee structure
• Indemnity insurance
• Minimum levels of investment
• Membership of industry bodies

1. Qualifications, experience  and areas of expertise

A good advisor probably comes with a dose of industry experience, good qualifications and expertise in the basic building blocks of financial advice; a working knowledge of investments, insurance, medical schemes and retirement planning.

One of the most prestigious financial advisory qualifications is the international CFP (Certified Financial Planner) qualification. However, many competent advisors have legal or commercial degrees from South African universities.

With respect to the advisor’s areas of expertise, FSB statistics show that well over 90% of advisors have competence in the insurance industry, followed by 40% in the investment industry, 28% in the medical scheme industry and 25% in the employee benefits industry. A survey by Moonstone done in 2012[i] gives a rough idea of the areas of expertise amongst South African financial advisors.

2. Fee structure 

You can choose to pay advisors in a range of ways. According to Eugene Maree, a common understanding of the proposed RDR legislation is that it will ban commission based structures, but another interpretation of the policy documents in the public domain is that the primary purpose of the new legislation will be to seek fee transparency of every service provider in the chain of supply. In short, if the commission structure is understood by the client and agreed by the client, it may remain the payment mechanism of choice. Alternatively, clients can choose to pay a fee-based tariff or a combination of both.

Certainly, commissions have been the traditional payment option, but internationally more financial advisers and their clients are electing fee only financial planning where clients pay per hour or per task, irrespective of whether products are sold and which products are sold.

One of the areas that the proposed RDR legislation hopes to tighten up on is correctly prices and structured after-sales service. Ask your prospective advisor what services are offered and how these services are charged for.

3. Indemnity Insurance

The objective of professional Indemnity Insurance is to cover you for claims against the financial adviser resulting from bad judgment or negligence on the advisor’s part. The cover is limited to the value of the advisor’s insurance policy. Before you engage an advisor ask what the value of his or her policy is, and whether or not a claim has been made by the advisor on the claim.

4. Minimum levels of investment

Financial advisors design their businesses with different clients in mind. Some are directed at financially literate ‘self assisted’ clients who are familiar with the financial sector, other are tailored to deal with high net worth individuals who may have made their money outside the financial sector and are therefore new to the jargon, regulatory environment and so on. Still others aim their services at young professional middle class South Africans and take the view that these young people will be lifetime clients, and offer the range of products that such clients would require over a lifetime. Other business models are equipped to deal with clients who are less sure of the options available, require a financial plan and annual ‘face time’ with their advisor.

If you ask about the minimum levels of investment, you will get an inkling of where the advisor is pitching his or her business and whether or not this model suits your requirements.

5. Industry bodies

Find out which industry bodies your advisor is a member of. The two dominant industry bodies in South Africa are the FPI (Financial Planning Institute) www.fpi.co.za/  and the Financial Intermediaries Association FIA www.fia.org.za , an organisation focussed in the insurance industry.

More information on the Financial Advisory and Intermediary Services (FAIS) Act may be obtained from the Financial Services Board (FSB) on their toll free numbers 0800 110 443/0800 202 087, or visit their website at www.fsb.co.za.