The four big fixes for better financial planning

Financial planning has long had two major problems, and the intersection of the two problems is where the action is. The Royal Commission into banks is merely uncovering what most people in the industry have known for a long time.

Problem 1: Do Financial Planners provide advice or sell product?

If I go to a used car salesperson, I expect them to try to sell me whatever they have in stock regardless of what I need. If I go to see a mechanic, I expect them to solve the problem with my current car – not to try to sell me a different car.  There is little confusion.

Financial planning customers think they are seeing a mechanic who will fix their finances, but banks and financial planning companies reward planners like used car salesmen – the more you sell the more you earn. And if the royal commission has confirmed anything, it is that incentives matter.

If you reward your planners like used car salespeople, then natural selection will lead to the planners who are the most like used car salespeople staying, and the best mechanics leaving. I have seen plenty of good planners languish at the bottom of the bonus tables while the planner who owns an expensive suit, hearty laugh, strong handshake, loud voice at the pub but little else sits at the top.

Problem 2: Not that many people need expensive advice

The average person who is paid a wage, has a standard superannuation account and no complicated legal structures needs very little in the way of advice. For most, an initial boilerplate plan and a courtesy call once a year is enough. Maybe a few hours every five or ten years when they inherit money, get divorced or retire. Let’s call these people “easy clients”.

There are people who do need more complex advice, with trusts, multiple businesses, lots of variation in taxable income and/or international assets. Let’s call these people “hard clients”.

Most planners charge a very similar fee for both types of clients. i.e. the easy clients subsidize the hard clients.

The intersection of the problems

Let’s say you are an executive at a bank or financial planning firm. Your “mechanic” planners don’t make you much money, as they don’t sell enough. But when the royal commission starts, you will be grateful you hired these planners.

Your “used car salesperson” planner who has been busy convincing “easy clients” to sign up to whatever product pays the highest commission is generally going to be OK as well. Sure there are ethical issues overcharging clients, but those ethical issues generally don’t see you in the hot seat at the royal commission. And they probably earned you a six or seven figure bonus most years.

Where it all goes wrong is when your “used car salesperson” planner has strayed into the “hard client” realm. Those are the ones that end up with you in the witness chair at a royal commission.

Solutions?

Hopefully it is clear by now that relying on financial service companies to “do the right thing” is not a solution. It is also clear that this is not a problem with the banks, it is a structural problem in the industry.

One thing that I hate is the current “enforceable undertaking” punishments that get handed out: company pays a big fine, makes either no admission of guilt or a very carefully constructed admission and everyone pretends things are OK.

For example, last year as part of the interest rate rigging scandal, both NAB and ANZ copped a $50m fine each but nothing further. It boggles the mind to work out what crime anyone could commit that would be so heinous as to be worth $100m in fines, but not so serious that anyone should go to jail.

There are a few solutions that would help:

  • Clearly define legally the difference between those who advise and those who sell investment product and don’t let anyone try to do both.
  • Change the remuneration structure so that planners charge either a fixed fee or an hourly rate. This is going to require regulation – very few will do this voluntarily.
  • Increase the punishment for individuals – jail time should be on the cards. At the moment the equation, if you are planning on doing the wrong thing, is: Upside = million dollar+ bonus, Downside = lose your job, company pays a fine on your behalf. For many, that payoff is attractive.
  • Increase the punishment for companies. If you want to fix behaviour at the company level then you are going to need a much bigger shock than a few hundred million in fines.  Should AMP lose its financial services licence? There are huge risks to financial stability, tens of thousands of shareholders, customers and employees would be gravely affected. But, you would get decades of improved corporate behaviour from the rest of the market.

The two most important questions

  1. What would it take for a big financial services company to lose its licence? At the moment, I think the answer is that there are no circumstances which could arise where a big financial services company would lose its licence.
  2. What would it take for a lot of people to go to jail? I suspect the number of people who go to jail for crimes to date will either be zero or insignificantly different to zero.

I am hoping that the main things to come out of the royal commision will be changes to the law that will mean that next time people will go to jail and that companies will lose financial services licenses for the types of behaviour exposed at the royal commission.

If both of these don’t happen then I’ll see you in 10-15 years at the next royal commission so we can discuss the same topic.

Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

Follow me

Comments

  1. Your Problem 2 is important. Due to the cost of regulation (including PI insurance), getting financial advice will revert to being something only the wealthy will obtain and the moderately well off and below will have to fend for themselves.

    • Fin Planning is just about getting things roughly right, and not exactly wrong.
      Government should release a broad guidlines to say if your at this stage of life, this would roughly make sense re risk/insurance/structuring, for poeple to atleast have soemthing to compare their advice too. Far too many today are over insured, purely due to the high commisions paid. Planners not being able to recommend related products would be the key recommendation I’d make.

  2. Super Phoenix

    I want to keep as much control of my own fate as possible and also want to *know* how things work in general. I also believe that nothing can substitute the financial knowledge (and wisdom) one can gain from doing it yourself which I think is far more valuable than the financial gains it generates. But then again, intense pursuit of knowledge is not everybody’s attribute and I know I am in the minority.

    So the question becomes how best to help the handicapped.

    It may be akin to contemplating about the best business model for nursing homes – how best to provide quality services to the vulnerable members of the society in an industry where many operators are too happy to rip off unsuspected clients. At least it is easier for ordinary punters to spot rogue nursing home operators and words also spread quickly through grape vines.

  3. sydboy007MEMBER

    Not sure if an answer will son be Ai Robo advise. The AI system could see much more into your real life, and also analyse your psychology a lot better in terms of your risk tolerance.

    It prob wouldn’t hurt to have high school economic classes deal with real life issues around super and investment. Having been dudded by “advice” in the past, personal understabnding is the only immunisation.

  4. PeachyMEMBER

    Fee for service or bust.

    That’s basically it.

    All areas that involve commissions or similar Lae reward structures always attract dodgy sleazy operators.

    Coles never flogs me too much food or the wrong kind of food. Neither does my butcher.

    Yet Harvey Normal will flog me a $95 HDMI cable; the car dealer will sell me $1,500 paint protection and the real estate agent will charge me $20,000+ just for showing up on a few days and lying to everyone.

    • “Coles never flogs me too much food or the wrong kind of food. Neither does my butcher.”

      What types of food are typically in the areas where you are lining up to checkout (looking for an impulse purchase)?

      You know they spend a lot of time organising product placement on shelves, right? I understand some of that is aimed to sell their highest margin products, not the best option for the customer.

      It’s not as direct as the $95 cable, but similar practices would be across most industries in some form or another.

      • PeachyMEMBER

        I know. But the business model is still to sell commodity products. They get cute about it at the edges, which is fine.

    • >Yet Harvey Normal will flog me a $95 HDMI cable

      If it’s not Oxygen Free, unidirectional copper cable – you’ve been dudded!

      • Fabian AlderseyMEMBER

        After the local Dick Smith closed down, JB Hifi had no direct competitors at the Westfield mall. JB gave me the option of the $50 cable or the $80 cable. So I drove up the road and bought the $2.50 cable from Officeworks, works absolutely fine.

      • PeachyMEMBER

        You need to buy ANOTHER one, so you have two.

        Change between them every week – while the cable is resting in the off week, it gives the electrons time to recuperate to ensure always-crisp picture and sound quality. make sure you store it away from magnetic fields.

    • Fee for service will not solve poor advice. Self education is the only way, and a basic course will help you avoid 95% of the problems. And there is no excuse for paying $95 for an HDMI cable. If you aren’t paying $250 for the titanium lined anti-flux version then you are wasting your time. I have some if you want one…..

      Incidentally, the supermarkets spend millions on range planning, and I bet they know your shopping habits better than you without you even realising.

    • Mr SquiggleMEMBER

      Yes, but the real estate agent will provide hi-quality lies and will drive up in an Audi or BMW.
      You get what you pay for, remember?

      • RE agents don’t lie. You genuinely do have water views from next to the TV aerial. And that will only be enhanced when they knock down the 3-bedder and put 8 units in it’s place.

  5. GunnamattaMEMBER

    The two most important questions

    What would it take for a big financial services company to lose its licence? At the moment, I think the answer is that there are no circumstances which could arise where a big financial services company would lose its licence. What would it take for a lot of people to go to jail?  I suspect the number of people who go to jail for crimes to date will either be zero or insignificantly different to zero.

    I am hoping that the main things to come out of the royal commision will be changes to the law that will mean that next time people will go to jail and that companies will lose financial services licenses for the types of behaviour exposed at the royal commission.

    If both of these don’t happen then I’ll see you in 10-15 years at the next royal commission so we can discuss the same topic.

    This comes to the very essence of the issue.  As someone who left the field of law more than a generation ago because I had cast aside my childhood thoughts about law being for the betterment of society, and realised law was simply about the defence of vested interests, I would observe this is a question of law and the creation of laws first and foremost.

    To take the analogies a step further if we catch people murdering other people and can prove they did it, we slap them in prison. 

    We don’t slap lying and stealing financial planners in prison because built into our legislative process is the half-baked understanding that a little bit of that lying and stealing is somehow good for us.  That sentiment is shaped by utter bullshit mantras like industry self-regulation, and the idea that not complying with a range of legislative requirements like workers entitlements, or audit requirements, or even paying taxes, is somehow more ‘efficient’ than doing so, and that in that improved ‘efficiency’ there is a dividend for all of society rather than just the executors, managers or owners of the capital deployed in being more ‘efficient’ that way.

    Beyond that there is the ‘contractisation’ of society too.  The behaviours of the banks are just another example of the behaviours of corporates across the board – the insurance companies, the energy companies, the telcos and on – they just want you to sign a contract with them, and it doesn’t matter how much bullshit they spin you to get you to sign.  The laws of contracts by definition work best for those with greatest access to capital to deploy on using them. That means anybody’s scope for taking a contract to court for failure to deliver is fairly minimal.

    But even before anybody goes to court, just getting in touch with these companies about any issue – and again the banks and financial companies are a standout – involves a raft of phone banks and hash keys and recorded messages, and waiting on line, and exhortations to do it by the web.  Then you get the ‘Your call is being recorded for coaching purposes’ message – which is deliberately designed to put the caller back in a box – leading up to a peon with a ‘script’ trying to fit you into a corporate narrative, regardless of what you think your issue really is, and how you see it. 

    Another way of seeing the behaviour of the banks is to see the insider versus customer dynamic.  Outsiders get robo letters, phone banks, 95 zillion bits of spam in their inbox or junk mail in their post exhorting them to sign up or miss out.  If they sign up, sure as night follows day, the moment they have an issue with whatever service they are supposed to be receiving, they will still be paying for the contract they signed up for.  But the insiders, well no matter what happens with the advice or services they sign people up for – they get to take their bonuses and their salaries and resign at leisure (if they are really unfortunate) and they get choices all the way along.

    And underpinning all this – yep it’s our legislative arm, the politicians.      They create the laws embedding industry self-regulation, and they tell you it is more efficient and they provide tax break for speculation while penalising genuine economic endeavour, and they want you to get out there and spend and turn a deaf ear if you think you have issues supporting the contracts they want you signed up to.  And all the while they (on both sides) embed themselves into the capital side of the dynamic to better the outcomes for themselves and their own attaching themselves to nice little earners and ‘opportunities’ when they spot an enfilade through which people are being channelled and fleeced.

    The only thing which will not see us back here in 10-15 years time is an electorate so profoundly hostile to all the players in this game that heads are put on sticks and the game gets changed.  If that doesn’t happen the main players will take the reset but just play the same game over again, the same old way, with the same old outcomes.

    Rant/

    • Or more simply, laws are made by the rich for the rich.
      And this is the outcome of that.

      • Whoops! Got that wrong… hang them first, then chop their hand on second… Oh well! 😀

  6. As someone who owns a public practice firm, and has avoided the push towards financial planning (and more recently mortgage broking, I’m convinced nothing will change. There are way to many snouts in the trough for real change to occur.
    The answer is simple. ALL conflicted remuneration should be outlawed. Not just in financial planning but also in the rest of the FIRE sector.
    Have a look how many tax compliance forms have moved into ‘business services’ with in house planners, brokers and even RE agents. The whole point of this business model is to move away from ‘fee for service’ and get the commissions, trails and kickbacks. I can’t see things changing any time soon particularly given the problems within both the CPA’s and CA organisations.

  7. I think prison time for crime in the industry might work, but it has not only to be implemented, but seen to be done.

    Imo business in Australia is very opaque so the whole system needs changing not just the investment side. Any real changes are most welcome and I hope it happens. Too bad for those of us who’ve been fleeced.

    • Nah – bugger that! Too expensive to keep those human skins alive. Confiscate wealth, execute summarily… done! Do that for all of them in a year (Duterte style) and watch the rest of them literally do or die.