Investment: Rules of engagement

The Retail Distribution Review of consumer financial services is here. A key question, discussed at Prospect’s RDR conference in November at the London Stock Exchange, is: now that investment advice must be explicitly paid for, will this new system improve our returns? I can’t point to any reason why, on its own, it should, but I can see one compelling reason why, in practice, it won’t.

There is great uncertainty in the advice market at the moment and fears that investors won’t pay for something that many had previously regarded as free. Not surprisingly, therefore, many advisers will carry on taking their payment via a direct levy on the client’s portfolio, either as a percentage or a fixed fee. So the adviser need not demand a fee directly—and the investor need not write a cheque. Less painful all round.

But allowing this to continue means that investors’ returns will show little or no improvement as a result of RDR. It’s repeatedly been shown that charges levied on long-term savings have a huge effect in reducing returns, because they neutralise the benefits of long-term compounding.

It is much better to write a cheque each year from your income than to pay out of your portfolio. Doing this will make clearer to investors the value they are getting from the advice they purchase, and will also stop the slow erosion of their long-term returns.

Transparency in advice is undoubtedly important—but unless it changes behaviour investors will not see the full benefit.