What the end of commission fees means for you

We were glad to see that the Financial Services Authority (FSA) wants to scrap commission fees for independent financial advisers (IFAs) from 2012.

In the long run, this will hopefully put pressure on fund managers to cut fees too. If the big fund management groups can no longer use commission as a tool to sell their products, they might have to start competing on a value-for-money basis.

That's good news because with the economy in the state it's in, investors are going to need all the help they can get to actually make a half-decent return in the coming years...

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Britain's financial regulator, the FSA, has taken a lot of flack in recent months over its handling of the financial crisis. Much of the criticism has been justified, although arguably most of it should be laid at the feet of Gordon Brown and his 'tripartite' regulatory structure which seemed to be almost deliberately designed to allow big problems to fall between desks rather than the FSA itself.

So credit where credit's due the decision by the regulator to target commission head-on looks like good news for consumers. Allowing companies to pay financial advisers commission, rather than charging fees upfront, has never been a sensible idea. If an IFA is genuinely independent then they shouldn't be swayed by sales commission they'll just choose the best product. But if paying commission didn't work, then why would product providers spend any money on it?

Financial advice has never been 'free'

Some have complained that consumers won't be willing to pay for financial advice if they 'realise' it's not free. But that's just vested interests talking. For a start, people already pay for their financial advice. This way, they're just getting to see the cost up front. And if they don't want to pay for it upfront, the FSA suggests they should be able to have the cost deducted from their investment.

There's also an argument to say that if you can't afford to pay for your financial advice, then your financial situation probably isn't complicated enough to require the services of a professional adviser.

The FSA also wants financial advisers to have better qualifications (equivalent to at least the first year of a degree), and it also wants to clarify the difference between independent financial advisers who can sell anything and "restricted" advisors, such as bank staff selling their own products.

It's on this last point that the review falls down somewhat. As Damian Reece points out in The Daily Telegraph, "tied agents and the direct sales forces of insurers will still be paid by commission". Sure, they'll have to explain all this upfront. But it effectively leaves IFAs (who'll have to charge in advance) competing with sales teams in banks and insurers (who'll no doubt be tempted to fudge the whole fees issue as much as they can).

Why scrapping commission is good news for consumers

But this still doesn't mean scrapping commission is a bad thing. People who go to the effort of seeking out an IFA, rather than just plonking down in front of their local branch manager to be sold a range of overpriced products they may not need, deserve to get what they expect independent advice.

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Better yet, this move should start to put pressure on the fees charged by product providers themselves. Everyone knows the damage that charges can do to your portfolio. If you have to hand over a big chunk of your annual return to a fund manager, then your money will have to work a lot harder to just keep up with a bank account. Yet if IFAs are paid via commission, then fund management fees aren't necessarily going to be high in their minds when they choose a product for a customer.

However, when commission vanishes, a whole range of products once largely ignored by IFAs will become far more attractive. An IFA being paid upfront by a client is going to be focusing much more closely on value for money, than if they have an eye on the commission payment.

That means that actively-managed funds will have to start competing on a much more even playing field with the likes of exchange-traded funds and investment trusts. Without the lure of commission, an IFA might wonder why should my client pay 1.5% a year for a big-cap UK fund when an ETF will do the same job for less than a third of the fees?

What to do until these changes take place

So that's the good news. The bad news is that the changes (assuming they are accepted) won't come in until 2012. In the meantime, it's worth being aware of how to keep charges as low as possible.

You might be inclined to put up with hefty charges and fees when property prices are soaring and share prices are in a bull market. In fact, judging by the number of new 'performance fee'-type structures that have been introduced in recent years, financial services providers are counting on it.

But ignoring high fees is a luxury you can't afford now that the economy has turned down and markets are likely to stay volatile for a long time to come. My colleague Ruth Jackson will be looking at how to keep your fees down in our free weekly personal finance email, MoneyWeek Saver, out tomorrow. If you don't get the email yet, sign up for it free here.

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