Fool's Eye View

[ October 24, 2000 ]

Be Your Own IFA

By Bruce Jackson (TMFGoogly)

Independent Financial Advisors (IFAs) are an essential part of the financial services landscape.

That opening sentence may seem rather like a reversal of policy for the Motley Fool. We've long campaigned against IFAs, advising individuals to take control of their own financial destiny. We claim that with a little bit of education, it is possible to manage your own financial affairs.

Possible is the key word. The Motley Fool still believes that it is possible for you to manage your own money. In the almost 3 years of our existence, we believe we have helped to change the financial services industry, for the better. This couldn't have been done without your help, because you are the people who've stood up to bank managers and IFAs and demanded a better deal. That sort of pressure, and knowledge, eventually counts.

Fool Pressure

The two biggest changes to the financial services industry have been:

1. The dying endowment. We believe the Motley Fool has been instrumental in highlighting the great endowment rip-off. Because we are completely independent, we were able to say it as it really was -- endowments exist as an excuse to make the financial services industry rich at the expense of the consumer. DO NOT GET ONE.

(If you've already got one, here's an explanation of the different types of endowment, and some questions to ask yourself as to whether you should get rid of it. If you decide to get rid of it, here's how to do it. And good luck!)

2. The dying commission-based IFA. Unfortunately we haven't quite eradicated this beast, but we've certainly raised awareness about the inherent conflict of interest. Let me just reiterate:

It is in the commission-based IFA's best personal financial interest to recommend the product that pays him (the IFA) the most commission.

As the customer, you are the person who foots these commissions, and they can be quite substantial over a long period of time. That's significant. But worse is the fact that the IFA may, and probably does, direct the customer into a product that will not suit his or her financial circumstances -- because there's a very big financial incentive for the IFA to do so. The conflict of interest is very apparent.

We really do hope you don't take an endowment mortgage and don't take "advice" from a commission-based IFA.

This Is Reality

We also hope you'll take control of your own financial destiny. But unless the Motley Fool and our educational content become enshrined into the thinking of the nation -- ideally from school age -- this simply won't happen. That is reality.

Reality is that the majority of people will require some sort of financial advice. And the reasons for that?

a. Lack of knowledge.
b. They're scared, meaning risk-averse.

The Motley Fool can help with the lack of knowledge part. But we can't stop people from being scared. It's human nature to be both scared and risk-averse. Being a relatively conservative nation, the Brits are arguably one of the more risk-averse nationalities in the world. It's in our bones. Blame Neville Chamberlain. Or the French. Or the Romans. But whoever you blame, you can't change the facts.

(Warning -- that was a sweeping generalisation. Apologies to all those trapeze artists out there, and of course Eddie The Eagle.)

Use An IFA

If you feel comfortable using an IFA, use one. Make sure it's a fee-based IFA -- you pay them a set fee and they tell you the products they think are most suitable for your particular circumstances. That will take into account things like your age, income and risk profile. There should be no conflict of interest because the IFA gets paid the same amount of money no matter what products he recommends.

By paying the set fee, you think you are paying for the IFA's experience and knowledge. In fact you are paying for the comfort factor, and again that comes down to risk and an inherent fear of loss.

You're also paying a lot more than just the fee. But you're not paying in cold hard cash. You're paying in terms of underperformance. Research has proven that almost 80% of actively managed funds fail to outperform the returns of a cheap index-tracking fund. But that's exactly the type of products your fee-based IFA will recommend you purchase. They are generally called unit trusts. The chances are that you already own a few unit trusts. And main reason for their underperformance is their charges. How's this sound -- initial charges of 5%, and annual management charges of 2%? Not very attractive if you ask me.

Be A Fool

DIY Finance -- you can do it. How's this for a suggestion? Simply tweak your percentage holdings to suit your risk profile and your age.

1. Leave about 20% of your net worth in a high interest bank account. This should be a large enough amount so as to avoid you dipping into your share investments.

2. Invest the other 80% in a low cost index tracking fund.

3. Continue to make regular monthly contributions to your index tracking fund.

4. That's it!

By following those four simple steps, you'll have an excellent chance of bettering the returns of your IFA. You'll have control of your own financial destiny. And then you may want to then consider taking the next step.

5. Try beating the returns of the index tracker -- buy your own shares.

The IFA Cost

By using an IFA you are effectively sacrificing performance. In return you think you are getting a higher degree of safety and security. You may be comfortable earning a relatively smooth 7% per year, rather than a volatile 12% per year. That's fine. But be aware that's a real cost, and over many years -- courtesy of the power of compounding returns -- this performance difference adds up to an enormous amount of money.

£10,000 @ 12% for 30 years = £299,599
£10,000 @  7% for 30 years = £ 76,123
                             --------
Difference                   £223,476

That's an expensive charge. Still want to use that IFA? Perhaps I should re-write that first sentence!

Now What?

We've set up a poll to gauge your opinions on this subject. In order to vote, you'll have to be a registered Fool. It's quick, easy and simple. Just follow this link to register. By registering you can vote in our discussion board polls, post messages, set up and track your own portfolio, get special product offers, and keep updated on Foolish site and content improvements.

Can You Be Your Own IFA?

a. Yes -- it's easy.
b. Yes -- but not with a huge amount of confidence.
c. No -- I prefer to leave it to the experts.
d. No -- it's too difficult to manage my own money
e. No -- I can't handle the risk and volatility of the stock market.

Vote here. And whilst you're on the discussion board, tell us what you think about the whole subject.

Where Next?
• Buying An Index Tracking Fund
• Guide To Buying Shares
• Personal Finance discussion boards

Other Links
• Students Can Be IFAs
• Stock market crash tomorrow?