The old adage – never mind all the Wall Street broker’s yachts, where are all their clients’ yachts? – speaks volumes on the perils of asking professionals to help manage your money. Financial advice is usually a grudge purchase - you wouldn't pay for it if there was an easier way of managing your money. But you can be smart about who you hire and when. Warren Buffett’s $62bn fortune would be a mere $5bn if he’d been paying industry standard fees all the way up.
How does a sensible entrepreneur choose the right financial adviser?
Entrepreneurs face similar issues, regardless of their line of business. How best to optimise a business for tax; how to incentivise and reward employees most efficiently; how to raise finance against cashflows; how to manage property assets; – and many more. These questions are generally best answered by an accountant or, if you’re careful, by an independent financial adviser (IFA).
But the real fun starts with the money that you’ve taken out of the business - typically either as dividends, or by selling part or all of the company. What’s the most tax-efficient way to manage investments? How to provide for retirement? How to handle inheritance? How to manage my investments? And so on.
These questions are bread and butter for IFAs – though the quality of advice and knowledge varies enormously.
The reason why money men can buy so many yachts is the difficulty in distinguishing between luck and skill.
Your private banker recommended an investment; the investment doubled seven years later; your banker claims he is a genius and collects a handsome fee. But what if the overall markets tripled in this period? Or if the banker had taken a big risk that happened to pay off – does he still deserve his fee? And doubling in 7 years works out at 10% per year; after tax and fees this might barely cover inflation – so you’re paying to stand still.
Markets tend to rise with time, thanks to inflation and GDP growth, and financial advisers tend to take credit for this growth irrespective of whether they deserve to. The best investment managers deliver performance, after adjusting for the risks they take, that beat the market, and deserve their fee. But 80% of managers lag the market and aren’t earning their swag – they survive primarily because they claim to have skill for what is in fact their luck. What’s a poor entrepreneur to do?
There are no magic bullets, unfortunately.
The textbooks (but not the self-appointed experts) will tell you the most efficient way of managing your money yourself. Reduce tax and fees, diversify across assets, geographies and timescales, decide your asset allocation and rebalance periodically against it; prefer passive investments like index funds and ETFs to the more expensive alternatives peddled by the industry. We are also told to beware cognitive bias (a.k.a. human frailty); expect outperformance only where you have an informational advantage. But not many people have the time, interest or tools to follow the textbooks’ advice.
Choosing a Private Bank
Private banks play to egos and are rarely considered dispassionately. Yet one top tier private bank targets its bankers with earning fees of 4% of clients’ assets per year – a transfer of yachts if there ever was one. Many private bankers often appear to have only one thing on their mind – Structured Products. But if you’re tempted by a private bank, consider the following:
- How wide a product range do they offer? Most banks will claim to be whole market. But can they access Vanguard’s award-winning low-cost ETFs? Can they access high end hedge funds? Can they trade ETFs in non-mainstream markets like Australia and Brazil?
- How clear is their reporting? My bank can’t provide me with an integrated bank statement, but has to use Excel to tot up totals whenever I sit down with them. I can’t quite understand why I am still with them.
- How are the fees structured? Am I paying a percentage of assets? All assets or just assets that aren’t the same brand as the bank (for which I expect to paying underlying fees anyway)? Are transaction fees on top? If I want an execution-only account, what fees apply to that?
- What sort of service level is provided? Is it a named person? Will they answer the phone – at 10am? At 6pm? At 10pm? Or will I be ringing a call centre to get my urgent US dollar bankers’ draft issued? Will they take email instructions? If they need signatures, will scans do – or faxes – or genuine parchment only?
- How original are their ideas? During a credentials meeting, any half decent banker will have half a dozen interesting ideas to put on the table. But how many will they produce over 12 months? Once you’re out of sight, you’re out of mind.
- How likely are they to advance you credit? You might not think you need to borrow money, but wait until you need some six figure liquidity in a hurry for that one-off investment opportunity and ask how helpful and expensive your bank might be in that situation.
Choosing an IFA
IFAs, in my experience, play a different role. Without the executional services that banks offer, they tend to focus on wealth management, inheritance planning, and the like. I’d ask around – and ask the following questions:
- What fee structure is on offer? A few IFAs charge the way dentists do – by the hour. Beyond a certain size of asset base, this ought to be the best way for you to pay for advice – but most high net worth advisers would much rather charge you a percentage instead. Are they up front about the percentages – do they mention trail commission, or do you have to bring it up yourself? How comfortable is this IFA with the upcoming changes (‘RDR’ – designed to stop the worst practices) that the FSA is bringing in?
- How objective are they? Very few IFAs will mention ETFs or passive index trackers, despite the clear advantages of using them. Almost none will suggest that the cash portion of your portfolio be put in National Savings, despite it topping the impartial league tables year after year. You can’t expect turkeys to vote for Christmas, but make you sure you know it’s a turkey when you ask it to vote.
- How clearly can they explain things? My favourite IFA should have been a school teacher – he has a wonderful way with words and a pencil. No time wasted, no misunderstandings. This valuable skill is rare, and I am happy to pay for it.
- Do they unearth new opportunities? A primary motivation for me using an IFA is ‘dealflow’ – seeing investment ideas I would not normally consider. Some IFAs are much better than others in this regard.
- Do they understand small businesses? Are they aware of the opportunities regarding company directors and SIPPs? Do they know the various ways of buying commercial properties? Can they help with building an employee benefits scheme? Can they provide you with ways of improving your cashflow – e.g. invoice discounting?
In reality, what is right for one client is unlikely to be right for another. Most advisers rely on word of mouth from existing clients to attract new clients – the preferred strategy of wolves seeking lambs since time immemorial. Caveat emptor.