The state of financial advice in South Africa

The dispensing of financial advice – in the true sense of the word – is still in its infancy in South Africa, despite the regulation of the industry and attempts by well-meaning organisations to gain professional recognition, writes Nigel Scott.

The realm of financial advice has undergone interesting changes over the last 40 years. In the late 1960s, there was very little financial advice around, and most financial products were distributed by agents of the product manufacturer. This manufacture and distribution model gained momentum during the 1970s with the emergence of the first brokers – intermediaries who had contracts to represent more than one manufacturer. These “independent” distributors grew in numbers in the late 1970s and through the 1980s. Before long, the value and volume of business generated by this segment of the distribution chain of the financial services industry was dominant. This led to much self-regulation from The Life Offices’ Association of South Africa (LOA), which represented the dominant manufacturers, to ensure the equivalence of reward between brokers and agents. If the truth be told, it also led to some dubious incentive schemes aimed at “buying” business from intermediaries. During this period, the focus was on distribution and volume. The only form of remuneration for intermediaries was commission, and the manufacturers were dominant. They decided what the public needed or wanted and they had willing distributors to spread the good news. It is also fair to say that the LOA had significant influence with the government of the day, and the industry certainly made lots of hay while the sun was shining. But, what of financial advice? In short, the “advice” dispensed was designed to facilitate and promote the sale of the product. In this respect it was incidental to the main purpose, which was product distribution. The nature of the advice related to addressing single needs, and the knowledge required for success was principally product knowledge. The 1980s saw the development of more sophisticated products using principles such as universal life costing. The packaging of product to meet multiple needs required more detailed product knowledge, but also some basic knowledge about the broader issues of financial planning. In recognition of this need, the ranks of legal advisers employed by life insurers swelled and provided the technical support for the distribution arms of the business. Further recognition of the increasing complexity of the product distribution environment saw the establishment of the ILPA (Institute of Life and Pensions Advisers) in the early 1980s. This eventually become the Financial Planning Institute (FPI), despite significant opposition at the time to shedding the “life” umbilical cord. International recognition came in the form of the accreditation of the FPI as the custodian of the Certified Financial Planner (CFP) mark in South Africa. This in turn led to the internationally accepted six-step financial-planning process becoming the benchmark for professional financial planning in South Africa. The advent of regulation under the Financial Advisory and Intermediary Services Act (FAIS) completed the circle in this regard. What about advice? The key question is what influence these changes had on the way financial advice is dispensed in this country. An important indicator would be how the public perceives the role of a financial adviser. A quick search on the Internet produces the following descriptions: “A financial adviser is an individual or a firm that is licensed… to carry out the business of advising on and selling financial products”. Interestingly, the affiliation of advice to product is still very strong. The same search revealed the following definition: “A professional who analyses a client’s overall financial situation and develops a comprehensive plan that meets his or her goals and objectives. The six main areas of a comprehensive financial plan include the financial planning process, risk management, investment planning, tax planning, retirement planning, and estate planning”. It is clear that there is no consensus view on what a financial adviser is and what he/she does. It is therefore not surprising that the man in the street will get a vastly different experience when dealing with an adviser fitting the first definition as opposed to dealing with an adviser fitting the second definition. The two types of financial advice It is also not surprising that the financial services industry itself is confused about the concept of financial advice. To understand this confusion, it is advisable to divide financial advice into two compartments: • Advice about the product – necessary to support the sale; and • General advice – about the management of your personal finances, which may or may not include the use of financial products. It is impossible to conclude the sale of any product without providing some detailed advice about how the product works and how it should be used. Financial products are no different. A skilled salesman will know his product backwards and will be able to create a need in the mind of the client that the product will fulfill. It will also help if the salesman has some background knowledge about the environment in which the product will be used. It will further be really useful if the salesman can compare a few alternative products, giving the client the choice of manufacturer. This is the process the majority of licensed financial advisers use to do business in this country and around the world. Yet somehow the description of what they are doing has assumed the mantle of financial advice. To make matters worse, most regulators around the world have sought to regulate these activities under the guise of regulating “financial advice”. This has caused much confusion in the minds of consumers and has probably retarded the development of a profession of financial planning. In every other industry in which this process is applied it is called what it is – sales. Yet somehow when the product being sold is financial in nature, it changes its nature and receives regulatory sanction. The role of the adviser Getting back to the role of the financial adviser, further searches on the Internet define this role as: “The role of a financial adviser is to assist you to analyse your personal circumstances, accordingly compile a financial plan and recommend products to achieve your determined goals”. You will not be surprised to learn that this definition comes from a product manufacturer’s website. Yet again, the connection to product is overriding. Probably even more sobering is this definition from the website of a non-governmental organisation: “A financial adviser’s job is to help you sort out your financial needs and recommend financial products and services to meet them. “Some people find financial advisers helpful, as they can explain the pros and cons of different financial products”. Commission and fees The link between advice and product has led many industry players to conclude that the public is not prepared to pay for advice. People use this in defence of adviser compensation via commission. If we assume that most people equate financial advice to advice about the product and its application, then they are probably correct. Consider an example from another industry. You need a new pair of running shoes, so you go to a specialist sports store. The sales assistant, who looks like a runner, spends time helping you select the shoe that suits your running style, distance, weight and so forth. Then, at the end of the process, as you head for the pay point, he produces an invoice for his advice. How would you feel? Surely his advice is priced into the cost of the product? I am quite sure that a client buying a financial services product feels the same. A derivative of this argument about fees is that only the wealthy can afford to pay fees. If the not-so-wealthy and the poor cannot afford to pay fees, how is it that they can afford to pay commission? Conclusion The crux of this issue lies in the need to sever the connection between advice and product. In an advice-driven financial-planning process, a product simply becomes a tool that assists in the implementation of advice in certain circumstances. It provides the regulatory backbone to the implementation. Well-known coach to financial advisers, Bill Bachrach puts it this way: “Many financial advisers presume that people come to them primarily for their knowledge and access to products, programmes, and platforms. “This kind of thinking tends to lead them to act more like salespeople who over-educate, over-explain, offer choices and options, and leave the ultimate decision about which investments or how much insurance up to the client. Or, worse yet, the client tells them what they want to buy and they sell it to them”. Nigel Scott is CEO of H4 Financial Planning and a member of the Blue Chip editorial board