There needs to be a fundamental rethink about the relationship between financial advisers and their clients, writes Luke Staden, founder of Staden Financial Management.

In economics, there is a concept known as the Principal Agent Problem.

It describes an uncomfortable reality: what happens when the person you hire (the agent) has different incentives than you (the principal)?

Think of a real estate agent. You want to sell your house for the highest possible price, even if it takes many months. For the agent, however, while a higher price would increase his earnings slightly, it increases his cost a lot and he would be better off if he were to sell your house quickly at a lower price so they can get a slightly reduced commission and move on to the next client. Your interests are mostly aligned, but they aren’t perfectly aligned.

Now, bring that concept into my office.

As a financial adviser, I want to believe I always put your needs first. But the traditional business model of financial advice creates a severe principal agent problem.

The conflict of interest in the typical setup is as follows: an adviser is compensated the moment you agree to become a client. Whether through an upfront fee or a commission, the adviser gets paid immediately.

This creates a conflict. Onboarding a new client costs the adviser money (staff hours, compliance checks, and administration etc.). If the adviser were to conclude that, after some considerable investment of his time, “You don’t actually need an adviser right now,” he would lose money. Those costs now come with zero revenue.

But if he were to sign you up even though it were not in your best interest, he covers his costs and makes a profit instantly. In the traditional model, you can never be 100% certain that I or anyone else saying “yes” are doing so because it helps you, or simply because it pays me.

Breaking the cycle: I believe that to fix this misalignment of interests, we cannot just rely on promises, we have to change the maths. We must create a situation where putting your interests first is the only way to put my interests first.

That is why we are introducing a new way of doing business.

The core of this model is simple: The adviser must operate at a loss at the start of the relationship.

Under this model, we would not charge a large upfront fee that covers all my costs. Instead, the compensation is spread out over time. That would mean that when I spend hours building your financial plan and setting up your accounts, I am essentially investing my own money into our relationship. I am in the red.

In order for me to recoup my costs, I need to give you good advice and retain you as a client for a reasonable period of time.

Why this protects you

By taking on this financial risk, I change my own incentives:

1. I cannot afford to give you bad advice. If I recommend a strategy that doesn’t work for you, you will leave. If you leave early, I don’t just lose future profit; I lose the money I spent setting you up as a client.
2. I will not onboard you if you don’t need me. If I don’t believe I can provide value to you for the long term, there’s no point in me taking you on as a client. It would be financial idiocy for me to sign you up, do the work, and have you leave in three months. Let’s hope I’m not that much of an idiot?

Trust shouldn’t be something you have to hope for; it should be baked into the contract.

That is why Staden Financial Management is officially adopting this model. We are shifting the risk from you to us. We are confident that our advice provides real, long term value, and we are willing to put our own balance sheet on the line to prove it.

If we don’t deliver value, we don’t just lose a client. We lose money. And that is exactly how it should be.

Contact Luke Staden of Staden Financial Management to set up a meeting and discuss your particular financial needs or check out the YouTube channel.