Some IFAs are set to lose 40% of their income as commissions dry up.
If you were going to get your house insulated to save on your energy use, would you employ a firm that took a commission from your gas and electricity bills as payment? You wouldn't if you had any sense, because it would be in their interest for you to use more rather than less.
But when it comes to seeking advice from an independent financial advisor (IFA), that's the way many people pay for it. A lot of IFAs, you see, offer "free" advice and make their money selling you investment products that pay them a commission.
Some charge a straight fee and don't sell commission-based products (or if they do, they refund the commission to you), and we generally like those. But when we think about the attraction of getting paid (oops, I almost said "earning" there) a few thousand pounds in commission over the next few years rather than just a few hundred directly from the client -- well, it's not hard to see where the conflict of interest lies.
The shake-up is almost upon us
But that's all changing, in the biggest shake-up to hit the industry in years. The Retail Distribution Review (RDR), to come into force in December 2012, is the latest attempt by the Financial Services Authority (FSA) to bring some transparency to the IFA business. So how is the industry shaping up, with so little time left?
With the RDR demanding a transparent system of charges and a full disclosure up front of exactly what the client is paying for, and the prohibition of recurring fees charged for no additional work (yes, some products have repeat IFA fees built in for which they have to do diddly squat), it effectively brings to an end the days of commission-based "free" advice.
With eight months to go, one thing that seems very likely is that a good few IFAs will close their doors, after a recent survey suggested that up to a quarter of them will be facing a severe shortfall in their incomes. CoreData Research reckons that advisers who charge £100 an hour or less have been getting 42% of their money from up-front commissions, with higher-charging advisers taking a smaller slice that way.
More open competition
If they want to carry on in business, they're going to have to up their game and compete with the more efficient players in the market, rather than relying on punters being seduced by low fees or "free" advice. The truth is, when the full costs of doing business with commission-based IFAs is disclosed, investors will refuse to pay the levels of charges that were effectively being hidden from them before.
So we're likely to see some consolidation in the business, with smaller firms being taken over by larger and more cost-efficient organisations, and with a lot just closing down altogether and retiring.
And we're going to see a change in the range of investment products sold. A long-term favourite strategy among IFAs has been to get their clients to invest their money in a range of share-based funds like unit trusts and open-ended investment companies (OEICs), which paid them fat initial commissions, plus those repeat annual renewal commissions.
Once these vehicles fall out of favour, we should hopefully see funds moving more towards investment trusts, which are an altogether more Foolish choice. They have no shareholders other than you the investors, and don't pay out commissions to advisers.
Do you need an IFA anyway?
But with these new steps towards openness and transparency, you might be wondering whether you need an advisor at all. Well, not surprisingly, here at TMF we generally think you don't.
Investment trusts are easy for you to buy shares in for yourself, using a cheap online broker. But simpler than that, a FTSE 100 index tracker fund is probably going to beat anything an IFA is likely to recommend over the long term -- stashing away some money in a cash ISA and the rest of your investment funds in a tracker fund wrapped in a shares ISA is a sound strategy that would suit a lot of people.
And if you want a bit of variety and control but still don't fancy picking your own shares, there's a whole range of exchange-traded funds (ETFs) available these days, as Harvey Jones highlighted recently. You could do a lot worse than buy shares in something like the iShares FTSE 100 (LSE: ISF) fund, for example.
Do you use an IFA? Are you going to carry on doing so after RDR crunch day? Do share your thoughts, below.
David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors Of 2012" -- while it's still free!
Further investment opportunities: