16 – The role of the institution
You will hear Dover say this time and time again: institutions are not your friends.
Institutions sell things. Often, those things are quite useful. Life insurance policies, for example. If a client needs a life insurance policy, then an institution is the only place where they can buy one.
So, life insurance institutions can be useful. This can mean that ‘traditional’ life insurance advisers are very used to relying on institutions. This group of advisers, in particular, can find it difficult to contemplate a financial service that does not involve an institution.
This is a pity, because in other areas of financial planning, especially investment management, institutions are more like a competitor than a colleague. Think about it: your client has a fixed budget that they can afford to spend on financial management. That budget needs to be shared between you (the adviser) and anyone else who wants to take a fee from the client. For an investment, that means the voracious fund manager. The more the fund manager gets, the less you can charge for your service.
Broadly speaking, there are only three types of investment available to clients. Property (a ‘growth’ investment); shares (a ‘growth’ investment) and cash/fixed interest (a ‘preservation’ investment. This last category includes bonds and similar instruments). Institutions tend to concentrate on the share market (although there are some that look to insinuate themselves into property management as well). And many risk advisers, used to seeing institutions as a necessary part of financial planning, choose to advise their clients to invest into the share market via an institution.
In doing so, those advisers not only increase the fees paid by their client (which has to reduce the effective return), but they also reduce the fee that the adviser can charge themselves. The client, who takes all the risk, loses. The adviser, who does all the work, loses. The institution, which does nothing other than insert itself unnecessarily between the client and the market, is the one that wins.
As we explain in the Dover Way, institutions are simply not necessary for most share market investments.
The LIF reforms limit the amount of commission that is available. Across the life of a policy, commission income will fall by about 20% on average. There are only two ways to make up this reduction. Either work 25% harder, or find alternative sources of revenue. Alternative revenues must come in the form of fees paid by the client. And the amount that clients can afford to pay is limited. If the institution takes a cut, there is less for the adviser.
For that reason, advisers need to be very careful that they only use institutions where those institutions actually bring something to the table.