Richard Rogers talks RDR and how it may affect you
Understanding financial advice and what the RDR means
Most people who have received financial advice in the past will be aware that the advisor who provided them with the information they received will have been paid through commission, in the majority of cases. The attractive trait commission has is that it doesn’t require you to physically dig into your pockets and produce an upfront payment to your advisor, while from an advisor’s point of view they know exactly what they will be paid. However this does mean that in many cases you are unaware of how much the advice has actually cost you – and ultimately it is you that will pay for it.
What is the Retail Distribution Review?
The Retail Distribution Review (RDR) will be introduced after 31 December 2012 and will aim to change the way advice is given, ultimately making the process easier to understand while ensuring (in theory) that the standards of advice given are maximised.
In order to achieve this, the Financial Services Authority (FSA), who are behind the RDR, will make three core changes: charges that are easier to understand, more highly qualified advisors, and clearer definition as to the different types of advice.
Why the changes are needed – an example:
In order to understand what the FSA currently see as shortfalls in the process of financial advice, let’s consider an example.
Two different people have two different lump sum amounts they want to invest. Person 1 has £100,000 and Person 2 has £10,000. They are both unsure as to what would be the best investment, so decide to contact a financial advisor.
They both go to the same financial advisor, who as a rule charges 3% commission on investment amounts as his payment. Because the advice given is similar for both Person 1 and Person 2, it takes 6 hours in each case to conclude the advice. At the end of the six hours, the service received by both Person 1 and 2 is the same, but the amount paid to the advisor varies significantly:
Person 1 - £100,000 invested at commission rate of 3% = payment to advisor of £3000
Person 2 - £10,000 invested at commission rate of 3% = payment to advisor of £300
As you can see from the example above there is currently no direct link between the amount being earned by the advisor and the amount of work involved. The has led the FSA to believe that advisors are motivated to provide solutions to clients that are likely to earn them more commission, over those that are actually in the best interests of the client.
The three changes
As mentioned previously there are three main areas of the advice process that the RDR is hoping to improve.
1. Charges that are easier to understand.
You would be forgiven for answering ‘I don’t know’ when asked how much it cost you to sit down and talk to your financial advisor last. The RDR will change this however, in that your advisor will now have to explain exactly how much the advice will cost, and will have to agree these charges with you before the advice process begins. Using the example from earlier, this means that the same advice that cost two different people £3000 and £300, would now cost both of them £600 if, for example, the agreed rate was £100 per hour.
2. Better qualified advisors
There will be a higher minimum standard of qualification introduced by the RDR that all advisors must obtain. The current standard requires advisors to be qualified to at least level three of the Qualifications and Credit Framework, which is a comparable level to that of an A-Level. From the 31 December 2012 however this standard will be increased to level four, which is a similar level to that of the first year of a university course.
3. Clearer definition as to different types of advice
Not all advice will be subject to upfront fees. Whether you are required to pay an upfront fee will depend on the product in question. There are two types of product: In Scope Products and Out of Scope Products. In simple terms, In Scope Products are those that have an investment element within them, such as personal pension plans and individual retail investment products. Out of Scope Products are those that have no investment element within them such as general insurance products and equity release products.
Your advisor may also be either ‘whole of market’ or ‘restricted’. Being whole of market means they will be offering products from all providers, while being restricted will limit the scope of the products available. If your advisor is restricted they will have to make this clear, and will also have to explain what the restrictions will mean when providing you with advice.
So who wins and who loses?
This can be explained simply by referring back to our example. In a nutshell the more you have to invest, the more you will benefit from the RDR. Because commission was worked out as a percentage of the investment, the more you invested, the more you would pay. This means then that the higher your investment the more the RDR will save you. On the other hand though, those with smaller amounts to invest, typically below £20000, will fail to see the value in paying for financial advice.
In fact, many high street banks have stopped providing an advice service for their customers whose holdings are lower than £50000, because the increased costs of doing this will not make it worthwhile.
So the winners are those with large investments while those who have less to invest are likely to pay more than they would before the RDR. Due to this I expect to see far more people turning to the internet for help, and to sites like financialadvice.co.uk.
A quick, simple RDR guide:
• You will have to pay hourly fees to your advisor for advice on products that have an investment element within them from 31 December
• The Retail Distribution Review (RDR) aims to make advice clearer, fairer and more effective
• If you are investing a sum over £20000 the likelihood is that the RDR will save you money
• However those investing lump sums below that amount will likely have to pay more than before the RDR for advice