Experts argue that paying typical fees charged rather than commission usually only results in financial savings if you are rich to start with, writes Laura Slattery

People who have so much wealth to their name that they can't quite put a figure on exactly how many investment accounts, bonds and shares they own, typically employ the services of a financial adviser who will keep track of it all for them.

But choosing the method of payment for these services is a far more complex matter than simply deciding on cheque, credit card or cash-laden brown envelope.

Some brokers charge fees but many operate on a commission basis - i.e. they get paid by the insurance company or investment firm providing the product.

Of course, this doesn't make the financial advice "free". As the provider subtracts this commission from the value of the fund, either way the cost of advice and ongoing services comes out of customers' pockets.

But within the fees versus commission dilemma lies a menu of further choices.

For example, what do advisers who charge fees do with the commission they still receive from the provider? How are fees calculated?

Mr Ian Mitchell, managing director of authorised adviser Burns & Mitchell, says he charges a fee and gives the commission back to the client. They can then reinvest it or use it to offset the fee.

"It's not our money, it's theirs," he says.

In the fees versus commission debate, Mr Mitchell says his firm is "coming down quite heavily on the fees side", to the extent that he is switching some high net-worth clients out of products on which they are paying commission and then reinvesting their money, often into the same products.

This is in exchange for a fee considerably less than what the client would have paid in commission over the term of the investment.

However, Mr Mitchell qualifies his endorsement of fees by adding that paying the typical rates charged rather than commission usually only results in financial savings if you are rich to start with.

"It's not wise for someone with just €10,000 to invest to pay a fee. At the top end, people pay fees. In the middle, there's probably some education that needs to be done."

Proponents of a fee-based system argue it is more impartial than a commission-centred approach, under which brokers might be tempted to channel business in the direction of the companies paying them the highest levels of commission.

But commissions must be disclosed under regulations monitored by the Irish Financial Services Regulatory Authority (IFSRA) and consumers can shop around for discount brokers.

"If an adviser won't quantify what the commissions are and won't tell the client what effect they will have on the investment, warning lights should flash," says Mr Simon Shirley of BDO Simpson Xavier's personal wealth management service.

"You tend to hear that commissions are bad, full stop. Fees are good, full stop. It is not as clear-cut as that," he says.

Investors used to be charged bid-offer spreads of about 5 per cent when entering commission-based products, Mr Shirley notes. "So, on an investment of €100,000, the provider deducted €5,000 and just invested €95,000."

However, in recent years, providing companies have moved away from bid-offer spreads and, instead, charge early encashment penalties on a sliding scale of 5 to 1 per cent over the first five years of the investment.

This is a better deal for investors, as advisers recommend a minimum term of five years for most investments anyway.

A standard initial commission for a broker will be around 3 per cent, Mr Shirley says.

"On €100,000, the institution will pay the introducer commission of €3,000. There's a number of things clients can do with that," he explains.

They can reinvest the €3,000 along with the €100,000 and pay a fee, but they will then have to pay VAT on the fee.

Alternatively, clients can get around paying VAT by letting the adviser keep, for example, €1,500 of the commission to offset any fee and take the other €1,500 as a refund or reinvest it.

"Where commission is not deducted from clients' original investments, the assumption would be that it is preferable that they would use commission to offset the fee, then reinvest the rest," says Mr Shirley.

"You would be taxed on a refund as income, so invest €101,500."

At BDO Simpson Xavier, any ongoing commissions, such as a proportion of the annual management charge on unitised managed funds, are classed as a credit against future work with clients.

It is important that all fees are agreed in advance and in writing, Mr Shirley adds, and that advisers don't send invoices to clients for initial meetings and follow-up phone calls lasting half-an-hour. "The thing that clients hate the most is being hit with a fee out of the blue."

While most fee-based brokers charge a fee on an hourly basis or as a fixed rate, some charge as a percentage of the money invested.

"We charge 2.5 per cent of the investment regardless," says Mr Tom Clinch of Clinch Brokers. The firm also charges an annual fee of 0.5 per cent for its ongoing services. "The reason we don't charge a fixed fee of €2,500 or whatever is that we don't want to restrict ourselves to high net-worth clients."

A €2,500 fee might be a good deal for someone with half-a-million to invest, but it won't be so reasonable for someone with just €50,000 in their bank account.

"In effect, what our clients are looking for is impartiality," he continues. "Whether it's a with-profit bond or a tracker bond or a managed fund, we're not going to be swayed into doing one thing or another."

With this system, it will help clients if they deploy some of their own financial common sense before making an appointment with their broker's office.

"We might advise clients to use some of the money to pay off their mortgage and we will charge them 2.5 per cent of what they use to pay off their mortgage for the advice," Mr Clinch says.

This might sound harsh, but Mr Clinch argues that a commission broker will have no incentive to tell someone to pay off their mortgage before investing, even though it is often the most sensible approach to take.

The IFSRA has no plans to look specifically at the issue of fees versus commission, but the regulator is looking at the current codes of conduct.

A spokeswoman for the IFSRA said advisers must be upfront about how they are going to be paid, whether it's by fee or commission.

"At the end of the day, being blunt about it, we don't mind who pays us for our advice," Mr Shirley concludes.

"Obviously, a pure commission system is not in the best interest of clients. Charging fees for your professional services is in the best interest of clients.

"It's the payment of those fees where there is a grey line," Mr Shirley adds.