Analogies can be very helpful in clarifying our thinking on complex subjects like managing wealth. If you are wondering whether you should upgrade from an Independent Financial Advisor to a professional wealth management firm then this medical analogy might prove particularly apposite.
You might think of IFAs as being like the personal physicians of days gone by, when those with the means would have the same “generalist” doctor taking care of them throughout their life and where all treatment was based on their intimate knowledge of the patient.
As medical science advanced relationships changed radically, however. Innumerable specialisms evolved and patients began to be treated collegiately by as many experts as required. Rather than being quasi-friends, GPs evolved to become orchestrators of a variety of services, while treatment shifted from the home to a professionalised setting.
Wealth management has evolved in a similar fashion, and so it might pay for you to consider the treatment of your finances in the same light. Reliance on just one person fell by the wayside as medical requirements grew; in the same way, many investors today feel better cared for when their primary relationship is backed up by far wider expertise and infrastructure.
Intensely personal relationships can provide comfort and the fact that thousands of IFAs remain operating in the UK is testament to the loyalty many people feel towards their adviser.
But could those clinging to the IFA model actually be harming the health of their wealth long term? Often, we would argue that they are – and to a very damaging degree. Here is why:
IFAs are often very much more expensive – for reasons that aren’t obvious
Our users are often surprised to learn that using a wealth manager can be very much the cheaper option, despite what initial preconceptions (and corporate appearances) might suggest.
The potential savings can be immense. Our research shows that a client with £250,000 stands to save up £4,000 annually by switching to a wealth manager, while someone with a £2m portfolio could stop a staggering £40,000 slipping through their fingers each year.
To understand why, we need to unpick how many IFAs operate today.
An IFA is very often not managing your money at all – a wealth manager is
It can also come as a shock to learn that very often an IFA isn’t really the one managing clients’ portfolios at all and instead they have outsourced this to a selection of wealth managers (known as Discretionary Fund Managers). Industry figures suggest that at least half of IFAs use DFMs to manage clients’ investments today.
The rationale here may be sound, or at least on the IFA’s side. They might argue that by outsourcing portfolio management they are accessing the best expertise available and freeing themselves up for more “face time” with their clients.
But at what cost to investors?
In simple terms, having your portfolio managed by a wealth manager via an IFA adds another layer of (unnecessary) costs – typically in the order of an additional 1% per year, but possibly significantly higher. With this overlay, the IFA option starts to look expensive, even if the underlying wealth manager’s charges are very competitive.
Even small additional costs harm long-term investment performance; significant ones could prove a huge drag that is enough to scupper your financial plans.
Some estimates suggest that up to 70% of an investor’s real return can be swallowed up by charges. To illustrate the pain here, if an investor with a £1m portfolio pays an annual fee of 1% over ten years they will pay £155,752, while one paying 2.5% will shell out £364,335 – well over a third of their original pot.
To make your money work as hard as possible we advise seeking a Total Expense Ratio (TER) of less than 1.7%, including advice, and significantly less for portfolios of over £2m because of the pricing power that can be brought to bear. Anything above this is on the high side.
Also ensure you are getting decent returns. Research shows investors can reasonably expect a wealth manager to achieve gains 6% a year from a growth-orientated portfolio, net of fees. If the real returns you have been seeing are disappointing in this light, it might be time for a change.
Asking your adviser for a full breakdown of all costs and then weighing this against investment performance is likely to be a very illuminating exercise. Lacklustre returns combined with unjustifiably high fees really is no way to make money.
Your time-honoured relationship might be coming to an end already
There may be some who see that additional premium of 1% or more a year as a price worth paying for a personal relationship that stands the test of time. But here again investors might be somewhat in the dark.
Regulatory reforms have put the IFA model under intense pressure, forcing many to join up with larger firms or to even consider leaving the sector altogether. While they are scarcely likely to announce this to clients, industry figures suggest that around half of IFAs plan to sell off their business within five years – and many a lot sooner than that.
The notion that IFAs offer more durable relationships than wealth managers may no longer hold true. Moreover, difficult business conditions mean that many IFAs are now actively looking to shed “lower value” clients in order to focus on more lucrative segments.
If your business is worth less than £5,000 a year, you could find yourself being transitioned out. In contrast, many wealth managers have the scale and technological capabilities to service investors that IFAs may no longer consider viable. Several of the firms on our panel will work with those with just £20,000 to invest, meaning that the comprehensive capabilities of a full-service wealth manager are far more accessible than one might think.
The final diagnosis
Many of our users have come to realise that an IFA just doesn’t have the bandwidth to truly optimise their wealth and that the personal relationship piece no longer adequately compensates for impaired returns – if it ever did.
As our earlier medical analogy illustrated, getting the highest quality advice today calls for the kind of broad and deep expertise across disciplines which very few individual practitioners can embody solely by themselves. We might therefore question how realistic it is to ask one adviser to be an expert across all asset classes and markets at once. Massive intellectual capital is required to achieve good returns in today’s environment and logically this gives wealth managers a further advantage over their smaller peers, simply because their critical mass puts them in a better position to recruit the best brains in the business when assembling their teams.
None of this is to malign the expertise of IFAs. Just as in medicine again, experts often settle into private practice and doubtlessly there are talented IFAs in existence who can compare well to wealth managers on performance. It’s more that asking them to simultaneously compete well on price may be unrealistic if – as is so often the case – investment management is outsourced. Just like any other middleman, the IFA must get paid and so by definition they can often be a far more expensive choice.
And a choice it is, everyone must remember. In our experience, many investors have stayed with an IFA for far too long, out of loyalty, inertia or simply because they haven’t fully appreciated the cost and performance penalty they pay. Just as the internet has empowered people to take more control of their health, it has also allowed them to get proactive about managing their wealth. Trust is a great thing, but it is now within everyone’s power to ensure that they are getting the best possible treatment. It would be negligent not to use it.
If you suspect you could be getting a better deal on price and performance, get a second opinion. Simply complete our short online smart tool to start the process of upgrading to your best-matched wealth manager today.