This talk was given 12 November 2009
The text here may not be identical to the spoken text
National Skills Academy Financial Services - West Midlands Launch, Millennium
National Skills Academy Financial Services - West Midlands Launch, Millennium Point, Birmingham.
FINANCIAL SERVICES PEOPLE NEED
I’m Paul Lewis. I am a freelance financial journalist. I present Money Box and Money Box Live on Radio 4, do about two spots a week on Breakfast on BBC 1 and on the News Channel – the BBC used to call it News 24 but then its audience grew. The BBC is just one of my clients. I also write two columns a month for Saga Magazine – which some of you may see – I know at your mum’s at the doctor’s. As a freelance journalist, writer and broadcaster, I am not here representing any of my clients and in particular, because they get very antsy about it, not representing Money Box or, God forbid, the BBC. So any views I express are mine and mine alone.
I am delighted to be here speaking at the launch of the West Midlands Skills Academy – and my interest is in teaching financial skills. So I want to share my thoughts with you about what financial advisers are, what they should be, and indeed what they can be.
Let me start by reading you a letter. It was sent to me at Saga recently from a woman, I’ll call her Ann. She lives in a village in Staffordshire, not far from here.
“Dear Mr Lewis
I’m writing for advice about my pension and how to get the most out of it. I was born in July 1956 and so won’t get my state pension until I am 65. I have a private pension which is now with Prudential. I stopped paying into it when I had my daughter in 1994 and it has remained frozen since.”
Ann is divorced, a single parent, works part time as a self employed courier, no money to put into a pension now. She goes on.
“The current transfer value of my pension is £10,230. The pension at age 60 is expressed in today’s terms at £248 a year. Is there anything I can do that would boost the final yearly pension?’
Now this is bad news for Ann. But it doesn’t matter to the salespeople – they have had their commission. And it doesn’t matter to the insurance company that holds her pensions – Prudential as it happens. it is still deducting its charges.
Commission first. Under plans by the Financial Services Authority it’s going. And that is the best news for customers and for the industry for a long time. I just hope the FSA has the courage to press ahead with this and when it does that there is the political will to carry that through.
I’ve been preaching about the evils of commission for years. I have called it the cancer at the heart of the financial services industry. A rather mixed medical metaphor as the heart is one of the few organs in the body that is almost immune from cancer.
Why do I hate commission so much?
Because if the adviser gets paid for selling products then that creates a conflict of interest with the customer. The customer cannot know why the person sitting opposite them is recommending a particular course of action. And they cannot know why within that course of action they are recommending a particular product. All the time the adviser is paid for selling a product the advice is tainted. Now that’s not to say there are not thousands of honest financial advisers who are not affected by commission. Who give honest, fair and correct advice. But that’s not the point. The conflict of interest is there however honest the IFA is.
The alternative of course is to pay a fee. And certainly my advice to anyone who might be interested in a pension or an investment is find a good independent financial adviser and insist on paying them by a fee – in other words write them a cheque – and make sure that all commission they might be paid – including trail commission – is itemised and credited back.
And if the client says ‘I can’t afford to pay you £100 or £150 an hour. I don’t have that much money.’ Then the response should be ‘In that case you don’t need financial advice because you haven’t got enough money to make investment worthwhile.’
One key thing that financial advisers must be taught is the importance of turning down clients.
Now under the current plans commission – at least for IFAs – will go. But it won’t go for restricted advisers flogging the products of the bank they are sitting in. They will still get bonuses and remuneration deals that mean they have to sell a certain number or value of products. So their advice will still be tainted with self-interest. Now of course no-one should dream of taking so-called advice from someone who can only sell a limited range of products from the firm that pays them. But many people do. And ending commission there too is essential.
Even worse, it looks as if the FSA won’t end commission for sales of insurance products. The argument seems to be that there is no consumer detriment because insurance products are all very competitively priced and do what they say on the tin. But it still leaves open the possibility that people will be sold insurance that they do not need – life assurance to someone with no dependants, critical illness insurance to anyone rather than income protection cover, because the products pay a hefty commission.
Until commission goes – and goes completely – the sales of financial products will have the potential to be distorted by the self-interests of the people selling them.
People say to me what about washing machines, hi-fi, cameras, furniture that is all sold on commission by sales staff in shops – often calling themselves advisers or consultants.
That’s true. But there is a big difference between financial products and consumer products. If a consumer product doesn’t work then you find out fairly soon. If it doesn’t work it does not leave you in poverty. And if it doesn’t work you can take it back and get a refund. None of those is true for financial products. They are too important to have their sales governed by the ethics of a car boot sale.
And just ask yourself this. Would we have had the litany of mis-seling scandals from pensions, to payment protection insurance, to now structured products if no commission had been involved? Of course we wouldn’t.
So you will all have to get used to living without commission. Or your business will never become the profession you would like it to be.
Let’s go back to Ann. Her financial adviser took his commission and so had no interest in whether she carried on paying in or not. But his or self-interest was nothing compared to that of the pension provider.
Because hidden and high charges are also undermining any trust in the financial services industry. The standard charge on a stakeholder pension is now 1.5%.
The first thing to say about charges is that they are not FOR anything. They don’t buy you anything. They don’t buy you performance. Or a guarantee. Or a pension. All the time you are busily putting money into your pension pot in the top the provider has their own little tap at the bottom which drains money out at a constant rate. However well or badly the provider does their job.
The fee is taken as a percentage of your total fund. That means that even 1.5% takes a lot of your pension if you leave it in there for 40 years. Year 1. You put in let’s say £1000 – £83 a month. And the company takes 1.5% which is £15. That leaves you with £985. Year 2. You put in another £1000. And 1.5% is taken off that and another 1.5% is taken off your first year’s payment. So almost 3% has now been taken off your first year’s payment which is now worth a fraction over £970. And so it goes on. After 20 years your first year’s payment has had 1.5% taken off it twenty times bringing it down to £750. And at the end of forty years it has had 1.5% off it 40 times – barely half of it is left at the end. The result is that if you pay in for 40 years the provider has taken 25% a quarter of what you have paid in over those 40 years. You will have paid in £40,000 and the provider will have had just over £10,000. Now that’s without any growth. If your money grows then the percentage is even higher. If the growth is 5% before charges then the provider gets about a third of your entire fund in charges. About £40,000.
Now back to Ann. She paid in I reckon about £60 a month for let’s say five years – I don’t know but it couldn’t have been much longer than that because she stopped in 1994 and personal pensions only began in 1988. At 5% growth and 1.5% charges she would end up paying a third of her fund in charges to the insurer. So she gets £10,000 and the Pru gets about £5000. So it doesn’t matter much to the Pru that she stopped paying in 1994. Because every year it takes out its fees. Whatever happens.
Then her life changed and she stopped paying in. You might think that is unusual. After all pensions are a long term product. You put the money in and you don’t take it out until you retire. But the latest figures from the FSA out just a fortnight ago show out of 100 people who took out a personal pension in 2004 how many were still paying into it after four years in 2008. Any guesses? The answer is fewer than half. In fact for IFAs it is 44% stick with their pension for more than four years. 56 people out of a hundred had abandoned their pension within four years. For company representatives – those giving restricted advice as we shall call them soon – the figure is much the same – 54 out of 100 have abandoned their pension within four years. Although these are not quite the worst figures the graph shows a persistent downward trend as a bigger proportion of people abandon their pension plan within four years.
So most pensions are small abandoned pots like Ann’s making money for pension providers. If we just take personal pensions and stakeholders – not employer sponsored pensions – there are about 300,000 a year of those taken out – so 150,000 of those will be abandoned within four years. So there are clearly millions of Anns out there with small and useless pension pots the only purpose of which has been to pay commission on the sale and fees to the provider.
So the lessons here are these. When you advise a client on a pension. Make sure they understand the importance of paying in for life. Go back to them every few years and see what they have done. And even more important – because people will go away, you may lose track of them, you may get a different job your self – pick a pension with low low low charges.
Now the myth is of course that if you pay higher charges you get better performance. It’s not true. Every piece of research shows that active managers on the whole fail to outperform the market. Every year some of them do. But then every year some share clubs that meet in a pub outperform the market. But there is no way to predict who it will be. Good performance does not persist. And if an adviser says they believe it does and they can pick it then ask them if they will bear the loss if they are wrong.
But that is not how pensions and investments are sold. How many times have you heard the advice that you’ve got to take a risk to get a reward? It is part of the IFA’s mantra. And I have to tell you it is nonsense. If taking a risk meant getting a reward it wouldn’t be a risk would it? Risk means you might get a higher reward. But you might get a lower one. Or none at all. Or a negative one. But taking a risk to get a reward is one of the most costly false beliefs there is. And it is very widespread even among professionals.
I was in Canada this summer. The three largest public sector pension schemes in Canada lost 19% or C$72 billion off their C$385 billion assets in 2008 because their managers chose to put the money at risk in actively managed shares investments rather than keep it in safer bonds. Defending this approach Jim Leech, the CEO of the Ontario Teachers' Pension Plan, which lost C$20 billion, said ‘The fact of the matter is we have to take on risk to meet our pension promise.’ Oh Jim! If taking a risk guaranteed those extra returns you need so badly it wouldn't be a risk would it? The risk is you may lose another C$20 billion.
Perhaps he should have listened to Kelly Alles. She’s a teacher in Toronto paying into that fund and hoping it will give her the pension she has been promised. ‘A high return is great’ she told the magazine Canadian Business in July ‘but when it comes right down to it I'd rather have a guaranteed lower return’.
And you know there are only two choices for pensions. If you believe that the way to make the most money is to invest in shares because business is the engine which makes the economy grow – then hitch your pension wagon to the FTSE all share index and forget about it. All share rather than 100 index because with the all share you are not buying and selling component shares every quarter. And the less buying and selling you do the less cost you will incur. And those funds can be had for 0.5% in some cases. And prices are coming down. And that makes a big difference to what you get out at the end.
And the other is the Kelly Alles approach. Safe investments that will produce a positive return year after year.
Now the problem with that is of course that if you can’t exaggerate the return your pension will make – by using the 5, 7, 9% set down by the FSA – then people get frightened my how much they have to pay in to get the pension they need. They realise it’s not worth paying a small amount in. And you have to turn away business. Which in my book is a good thing.
Let me come back briefly to Ann. Whatever she should have done there she is aged 53 with her £10,230 pension pot and looking forward to living on the state pension at 65 with a boost of around £5 a week from the pension she paid into in the 1990s and of which Prudential has snaffled a third.
What do you advise her? Well you might mention the open market option, you might suggest that she doesn’t worry about inflation proofing. those two things could boost her pension in fact almost double it. You might ask if she smokes or if she has health problems. They could both boost her annuity.
But the problem she faces is that if she simply draws her pension whatever it is she will be very little better off. Let’s say she has worked or cared for children long enough to get a full state retirement pension. She will have at present levels £95.25 a week. But on a low income like that at 65 she would qualify for £34.75 a week pension credit to bring her income up to £130. That’s without her private pension. Now when she claims her pension she will get another £5 a week. And then her pension credit will be reduced. She will get not £34.75 but £32.30. So she will be just £2.55 a week better off for having her £5 a week personal pension. So all her savings and her £10,000 fund will leave her just £2.55 a week better off. And if you boost it to £10 a week she will still only keep about £6 of that.
But there are alternatives. First, her pension fund is less than £17,500. So she can take that as a cash lumpsum a quarter tax-free and the rest taxed at her marginal rate – let’s say 20% but if she times it right till after she retires it could be zero. But perhaps better still do it now. After tax at 20% on half the money she will have £8,695. And she can buy a five year bond with Skipton Building Society paying 5.35% annually which she can reinvest. So she is getting after tax 4.28% growth guaranteed for five years. And when she does retire she can take that as an income of more than £10 a week before tax. And it will barely affect her means-tested benefits because savings income doesn’t count as income and there is a £10.000 exemption on savings counting at all.
That is a much better deal for her than an annuity which will reduce her means-tested benefits.
So what does this tell us? Financial advice is not just about pensions, investment, insurance and mortgages. Those commission driven products that are its traditional mainstay. True financial advice looks at cashing in pensions if they are small, at the interaction with state benefits, at cash savings, and, for other people looking at debt, at credit cards, at budgeting. It also means telling people without much money not to save. Or of course to pay off debt which gives a much better return than any investment. And it’s risk free.
These are the range of skills of a true financial adviser. Not driven by commission and selling, but by giving real financial advice about real financial needs to real customers. That to me is true financial advice. And I hope that at this new venture to train financial advisers it will form part of the key curriculum here.