Plenty has been written in the commission versus fee debate where financial advice is concerned. The topic has once again surfaced in a paper titled “The Value of Financial Advice – It’s Not (Just) About the Cost.” The work was co-authored by actuaries, Colin Dutkiewicz, Steven Levin and Anusha Dukhi in their personal capacities, and presented at the Actuarial Society annual convention held last week.
The media release reveals that: “The authors hope that the paper will broaden the debate from merely a focus on costs to one incorporating the cost and value of advice to allow successful industry change that improves consumers’ financial affairs.”
Five measures of advice
The paper identifies and discusses five concepts that help to measure the value of financial advice. These include real value, community value, economic value, perceived value and statistical value. We will examine each of these concepts a bit further in an attempt to tie the concept of value to the advice given by an independent financial adviser.
As with most attempts to model consumer behaviour, a number of assumptions have to be made. For this study, the authors suggest that money has only one value – the purchase of goods for consumption. Furthermore, this consumption is either immediate or delayed. The act of saving money for future consumption expenditure forms the basis for their analysis. In other words, how much value is attached to delaying consumption expenditure – and by extension what fair ‘value’ accrues to the advice given by the financial adviser for assisting the consumer in making the decision.
The first step in this calculation is to determine what real value is. The paper proposes that real value “is the financial impact on an individual in real monetary terms, either immediately or some time in the future.” The authors propose the final measure for value in this category is net real value added, the real value added by the advice less the cost of that advice. The real value calculation is dependent on a number of assumptions, including those on future investment returns and inflation.
Considering the community
The authors use the concept of life insurance to demonstrate the value of financial advice to the community. They argue that “the advice to purchase life insurance is real value negative for the individual, but generates positive community value.” In other words, when an individual takes out life insurance, he is worse off by the premiums paid – and the dent in his consumption expenditure. Furthermore, the insured cannot spend the payout in the event of his death. But this sacrifice is value accretive for the community because they receive the sum insured in the event of the insured’s death.
Economic value is a concept the central bank governor, Tito Mboweni, has been trying to drive home for some time now. The report backs up the governor’s position. “Increased savings (delayed consumption) by individuals generally has a positive economic value.” While attaching an exact value to these savings is difficult, it is clear that higher levels of saving create a better macro economic environment.
Not all consumers see similar value
One of the anomalies identified by the authors in their quest for defining the value of financial advice is perceived value. They use an interesting example of a Stokvel to demonstrate how consumers are often quite happy with an investment outcome despite the fact there is no net real value added.
An investor paying R100 per month into a Stokvel is quite happy with the R1, 200 received after one year. By delaying monthly consumption expenditure of R100 – they get to make a single big ticket purchase in the future. So the consumer’s perceived value is positive, despite the real value being destroyed by the ravages of inflation.
“From an advice perspective it is therefore important to assist the individual to identify situations where Perceived Value Add is positive when the Real Value Added is actually negative,” states the report. This advice goes hand in hand with expectation management and ensuring the consumer is correctly appraised of the likely outcome of a certain set of investment decisions.
Statistical variations less important
The report concludes that statistical analysis is of little assistance in value analysis of an individual consumer. “The key is that statistical calculations work well when considering large numbers of individuals or pieces of advice, but for one specific individual the outcome will always be one of the extremes.”
The authors of this report include these five measures of value in their analysis of ‘the value of financial advice. And although we have just touched on the content of the 61 page report, their conclusions are welcome news for the industry. “The authors are concerned that the narrow focus on cost, without reference to value, will lead to incorrect conclusions and exacerbate the current savings crisis in South Africa.” A “focus on the fact that excessive costs can erode savings is necessary; but this should not be allowed to lead consumers into destructive behaviour patterns of avoiding investment advice and investment altogether.”
Editor’s thoughts:
The report made some interesting observations about perceived value. Do you experience difficulties in dealing with consumer perceptions (over fees or expected returns) when selling investment products? Submit your comment online - see below, or send your comment to gareth@fanews.co.za
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Added by MS, 19 Nov 2007