Are you getting good advice?

2011-04-02 11:24

A good financial adviser is worth their weight in gold. They are able to lead you through the complex world of finances, where there are often too many choices and the language used in policy documents is just too complicated.

One of the roles of a financial ­adviser is to make sure you have the right cover in place to protect your family and to ensure that you have a savings plan in place.

We are just too busy working and looking after our families on a day-to-day basis to worry about our ­financial futures, so we need someone whose job it is to do just that.

However, an adviser’s financial interest is not necessarily aligned to ours and an unscrupulous ­adviser may make recommendations that suit his or her pocket rather than yours.

You need to watch out for some of these practices and know what questions to ask.

Churning
One of the most common practices is “policy churning”, which is prevalent in the life insurance space. This is where the adviser recommends that you switch policies after two years of taking out the policy.

Advisers are paid the commission on the policy upfront. If the client cancels the policy in the first two years, the insurance house is allowed to “claw back” the commission from the adviser.

However, if the policy is cancelled after two years, the adviser keeps the commission. Large insurance houses say that they see a spike in cancelled policies shortly after 24 months, which suggests that some advisers are guilty of churning.

The adviser then sells a new policy to the client and makes another upfront commission.

What to ask:
» What are the benefits of changing my policy?
» What are the financial implications?
» What if I don’t pass the medical?

Surrender values
When your adviser wants you to cancel a policy, you need to find out if any penalties apply. This is particularly important in the case of an endowment or a retirement annuity through an insurance company.

For both of these products, the adviser is paid upfront for the expected duration of the investment. An endowment can be anywhere from five years to 15 years depending on the product and a retirement annuity assumes that you will pay a premium until you retire. The insurance house calculates the annual fee the adviser would receive over that entire period and pays a large portion of this upfront.

However, the insurance company recoups this fee yearly from the investment.

If you cancel the investment before the period is over, the outstanding yearly fees for the remaining period are deducted and you only receive what is called “a surrender value”. This practice was put under the spotlight by the Pension Funds Adjudicator in 2005 and today there are limits as to how much the value of the policy may be reduced. However, a reduction may still apply.

What to ask:
What are the financial implications of cancelling this investment or policy? Demonstrate the financial benefit to changing my policy.

Bad advice
This is a difficult one to identify. With the best will in the world, advisers cannot predict the returns of the stock market. The The Financial Advisory and Intermediary Services (FAIS) ombuds, which handle client disputes with financial advisers, say they receive many complaints about poor performance due to the market crash in 2008. This is not necessarily bad advice as long as the adviser has correctly assessed your risk profile.

If you are young and have a 20-year investment horizon, you have time to recover from a market correction. What you cannot afford is for your money not to keep up with inflation. Therefore, you would need to take some risks by investing in growth assets like property and shares. The adviser must make sure you understand the risks.

However, when an adviser recommends an investment that does not match your risk profile, you could have a valid complaint.

In a recent case brought before the ombuds, a financial adviser was found guilty of not assessing his client’s risk properly when he convinced a ­90-year-old pensioner to withdraw R560 000 from his Standard Bank savings account and invest it in the Old Mutual Dynamic Floor unit trust fund.

The pensioner needed a safe fixed investment to supplement his pension. The adviser had promised a 90% guarantee on capital and guaranteed income of R5 000 per month.

However, the product did not actually offer a guarantee and only “aimed” to protect the capital.

This was back in 2008, when the markets collapsed and the difference between “aiming” to protect capital and guaranteeing capital was made clear.

The adviser had to pay back the loss in addition to the interest the pensioner would have earned in his Standard Bank account.

What to ask:
» What does “guarantee” mean?
» What investment period is recommended for this investment and does it match my investment period?

Re-investing
Earlier this year I had an interesting question from a reader. He was retiring and selling his business. Because of the proceeds of the business, he did not need to cash in his retirement annuity.

His adviser, however, suggested that he cash it in and invest in a living annuity. Fortunately he asked a few questions before doing so. He is far better off not cashing it in until he needs it.

By leaving the investment to grow for a further five years, he could increase the value by about 60% – giving him a far cushier nest egg.

Even in retirement he could benefit from tax-free savings by adding to the retirement annuity, and finally, if he moved to a living annuity he would have to draw an income (which he did not need) and which would be taxed.

The only person benefiting was the adviser who would make the fee reinvesting into a living annuity.

What to ask:
Demonstrate to me the financial benefit of investing in a new investment. What would the financial implications be if I stayed with this investment?

Time is money
For certain products such as retirement-annuity policies and endowments, the longer the period you commit to invest, the more commission the adviser makes.

An endowment is a fixed-period investment. You have to continue to pay your premium every month otherwise it will be cancelled and you will pay “penalties” in having a lower surrender value as the commission has been paid upfront. Never agree to an endowment of more than five years – you can always roll it over for a further five years if you are happy with the performance and can continue to meet the obligation.

When taking out a retirement annuity, always choose the lowest retirement age, say 55 years.

For example, if you select a retirement age of 65 but want to retire at 60, it would be considered an early termination. Even if you choose not to retire at 55, you don’t have to cash the retirement annuity in and you can still continue to contribute.

What to ask:
What is the minimum investment period? Can I roll the investment over at the end of the period? What would my costs be to do that?

Make sure you understand
Many of the complaints received by the FAIS ombuds actually go in favour of the adviser. This is because clients don’t always fully understand what advisers explain to them.

For example, in one case before the ombuds a woman had complained that her adviser had changed her life policy without explaining the full financial consequences.

She also complained that he had taken out a policy with Momentum she was not aware of. The adviser was able to provide all the documentation, including all discussions that were held with the client with the client’s signature.

The adviser had done all that was required by the law, but sometimes clients do not feel confident

enough to admit that they do not understand in case they look “stupid”.

What to ask:
This is your money, your future and you are paying fees for the service in the form of commission. Always ask questions, no matter how trivial, until you are sure you fully understand.

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