Not long ago, shareholders were limited to a narrow range of investment options. Employing a stockbroker was only open to the very wealthy; Unit Trusts were in their infancy and considered too risky for most, and With-Profit funds dominated the pension and endowment market.
With-Profit funds were ok up to a point. However, they fell out of favour after several notable failures, especially in the endowment space. Various financial crashes and corrections jolted confidence in non-Bank deposit savings as investors weren’t fully prepared or knowledgeable to deal with the fallout.
Fast forward to today, and we are bombarded via TV and the internet by endless investment options offered by many providers. Selecting the right one can be a herculean task which is why most people seek an adviser to help decide which portfolio works best for them.
There are also many advisers to choose from, including banks, insurance companies and Independent Financial Advisers (IFAs). IFAs are usually able to provide a wider range of investment options as they have Terms of Business (ToB) with a variety of market providers. So, how do we select our adviser, and what should we look for?
The requirement for specific licenses to advise on investment options
First, you must be certain that the IFA truly works for you and has your best interests at heart. A good test is to request confirmation of all services provided and companies with whom they hold ToBs. This document should also clearly state fees, including initial and ongoing charges. Check the adviser’s regulatory status as well. Ideally, the adviser should hold a MiFID licence (Markets in Financial Instruments Directive).
The adviser should then gather sufficient information to make a proposal. Recommendations should be backed up with evidence proving suitability for your situation.
This is a point where caution needs to be exercised. If you are offered in-house investment funds, the independence of the IFA must be questioned. Is the ‘ABC’ fund genuinely the best available, or are there other reasons for the recommendation?
The latter is more than often the case. In-house funds are generally expensive and pay the IFA hidden fees. This is fine as long as these fees are fully disclosed before implementing an investment portfolio. Sadly, this is rare, and the true cost of a fund is only discovered when it’s too late or costly to change your mind.
Discretionary Managed Funds (DFMs) are popular for those who want another independent investment manager involved in the fund-picking process. A good DFM shouldn’t cost more than c. 0.80% per annum. Again, be wary about a DFM service which charges considerably more. The same applies to Managed Portfolio Services (MPS), where you buy into a ‘fund of funds’. A well run MPS can be a viable solution for those who don’t want too much disruption to their portfolio but do come at a cost. Expect to pay around 2.50% per annum for this option.
So, you have found a MiFID-regulated adviser who can offer you a DFM or MPS. Are there any other options? There should be. If a company has navigated the administrative minefield of obtaining a MiFID licence, it should be able to create bespoke portfolios for its clients.
Any adviser worth his or her salt should have the necessary skills to create a truly independent portfolio, sourced from a wide range of investment options and funds. This does take a little more time than simply offering you a DFM or MPS. However, the result should be a much lower cost and flexible portfolio.
Fund management fees for a portfolio selected from a range of Exchange Traded Funds (ETFs) and ‘Active funds’ should average out at about 0.60% per annum. Essentially, ETFs track indices and are ‘managed’ by algorithms. So, if you buy an S&P 500 fund, you will be investing in the 500 largest US companies with a small share in each of them. As there is little human interference, ETFs cost as little as 0.06% per annum. Few cost more than 0.50% p.a.
This isn’t to say your portfolio should only be invested in ETFs. Active funds, where real people are responsible for selecting the mix of securities, can also play a valuable role. ETFs perform better than Active funds 70% of the time in the major markets due to lower costs. The reverse is true in more specialist markets, despite higher charges.
For an IFA to be truly independent, it should offer clients a choice of investment options. If not, as Mr Henry Ford famously said, “You can have any colour you like as long as it’s black”!
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