Below is a reader’s question sent to Moneyweb which was featured in an article entitled “Is financial advice worth it?” Naturally it got my attention as this is a question I have had to answer to prospective clients.

Q: I will be going on pension at the end of this year at the age of 65. I have no debt and my home is paid for.

I have been involved with four different financial advisors, but cannot get away from the exorbitant costs that are involved. I have my pension and a separate retirement annuity (RA) and about R2 million in cash which they all would love to invest for me. I am left with the impression that they could invest my money to earn about 1.5% per annum more than I could, but since their fees will be 1%, it hardly makes it worth my while.

I now seem to think that my best option is to take my R500 000 tax-free allowance from my pension and draw down the minimum of 2.5% on the rest. If I subsidise myself from my cash reserves, I can survive for the first six years of my retirement while still leaving the rest of my pension to grow. I would not even have touched my RA yet.

However I’m still wondering if I  would be better off investing the cash amount through a financial advisor?

You can read the entire article here:

As expected, the response was sanitised, and designed to offend as few readers as possible. However, after reading the question a few times and pondering on the issues raised, I thought it I’d share my thoughts.

The first thing to note is the reader’s proposed solution to his retirement conundrum. What is clear is that the reader is applying a form of mental accounting. Investopedia defines mental accounting as “the tendency for people to separate their money into separate accounts based on a variety of subjective criteria, like the source of the funds and intent for each account” As a financial planning practitioner, I need to be alert to investor behaviors as those often have the greatest impact on investment success or lack thereof.

What this reader has clearly done is separate the various pools of monies he has, and ‘solved’ his retirement planning conundrum by supposedly taking a low drawdown from one pool, while leaving the other pool/s to grow. This would leave him with much bigger pools of funds after the initial 6 year period. At least he hopes.

What this reader has not seemed to consider is the variables that will impact his retirement over the long term. These include; income growth, portfolio returns in the early years, tax implications of his portfolio structure, portfolio risk and overall portfolio cost.

What he needs to do is maximise after tax income, while protecting capital and generating the required returns net of fees on a consistent basis. Applying mental accounting effectively takes him away from this as he no longer has a consolidated view of his total portfolio. It creates a disjointed approach which effectively derisks the short to medium term in his mind, and does not even consider the real long term risks.

Another observation; he notes that the four advisers / brokers he spoke to would charge an annual advice fee of 1%. That is an extremely high fee. Even if the adviser takes 0% initial fees, a 1% annual fee is guaranteed to place significant strain on an income portfolio. Once administration fees (0.25% to 0.60%) and asset management fees (0.30% to 2.50%) are added, the portfolio could have total fees of maximum 4.10% per annum. So a return assumption of 9% p.a. net required the portfolio to deliver 13.10% p.a. before fees. This is an incredibly high return for a usually conservative income portfolio. By way of benchmark we structure income portfolios for clients with a maximum total annual fee of between 1.40% and 1.60% p.a. (including advice, administration and asset management fees).

Back to the very important question raised by the article; is financial advice worth it? In my biased opinion; it can certainly be. However, the client needs to distinguish between cost and value. It seems that the advisers he spoke to charged commission only. He needed to look for advisers that would offer him the option of a consulting fee instead. This could have reduced the cost significantly. The value of advice, if done properly, would have come through in the form of a sound long term plan with clear and reasonable assumptions about the future, a budget, a cash flow forecast and analysis, a well priced portfolio, a well structured portfolio, tax structuring and proper implementation.

Good luck to him though. I hope he ends up with a proper retirement plan.