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“Save for a rainy day”. How many times did we hear that phrase from our parents and grandparents? In the current economic uncertainty, this is truer than ever but saving for the future can take different shapes and forms.

Do I put my savings in an investment product? Or maybe in a guaranteed pension plan? Or what about crypto assets? Consumers easily get lost in overwhelming amounts of information which is too often not reliable or accurate. That is why, for a decision as important as saving for your later days, access to timely, reliable, and independent advice is so crucial.

Why do consumers need help from an expert?

Financial systems are complex and major financial decisions are rare in most people’s lives, so getting help from an expert is the rational thing to do. But for that, we need experts available to help consumers.

In medicine, you can speak to a doctor, for legal issues you can find a lawyer, and even for your taxes you can speak to an advisor who is qualified to help you to the best of their ability. In finance, this does not hold true. When you walk into a financial institution to seek financial advice or if you speak to almost any other so-called “financial advisor” in most of the EU, you are actually talking to a sales representative.  

This person receives inducements (commission fees) to sell financial products like life insurance or funds. The higher the inducements, the more attractive a product is to sell. The problem is that these inducements translate into costs, which reduce net returns for the consumer. However, returns are the very purpose of an investment, especially in long-term investments like pension plans. This means that inducements promote an adverse selection problem: The worst investment products are the most attractive to sell.

Picking up the bill for bad advice

For an established industry, this is convenient because they do not need to compete on product quality. Instead, they can be sure their products will be sold if they provide high enough inducements to the salesforce, money which they take from the consumer’s investment and not their own pocket. This keeps more appropriate and cost-effective products for consumers out of the market because they won’t be distributed since so-called “advisors" will receive fewer commissions. 

A recent study from the University of Regensburg used OECD data to measure the harm of inducements to consumers in the EU per year: a staggering €375bn.

In our campaign “The Price of Bad Advice,” BEUC showed how harmful and detrimental conflicts of interest in financial advice can be to consumers. In almost all EU Member States consumers have been affected by mis-selling scandals that led to significant financial losses. And this is just the tip of the iceberg.  

A recent study from the University of Regensburg used OECD data to measure the harm of inducements to consumers in the EU per year: a staggering €375bn. That is how much money households are losing because of the commissions-based system. Similarly, the European Commission’s Directorate General for financial services (DG FISMA) found in 2022 that retail investment products are 25% more expensive for consumers than products for institutional investors. This is unacceptable. 

A question of trust

Consumer surveys show that people do not trust capital markets and financial advisors and that trust is a major factor in market participation. Consumers also keep much of their money uninvested, whilst much of the money they do invest underperforms significantly, as shown above.

This is not a problem of transparency: what would consumers who receive bad advice do? They can accept it and take the loss in opportunities. They can get bad advice from a different seller with the same result. They can try to become financial experts – but who has time nowadays to study very complex regulations? Or, as happens too often, they can disengage.

What’s more, independent advice is key to achieving acceptable financial outcomes for consumers, and also to help people invest more sustainably. However, people today are being steered towards products that not only harm them financially but which are not aligned with their values and real investment intentions.

Fixing a broken model

The good news is that the European Commission is well aware of the problem and has taken some steps to address it in its recent Retail Investment Strategy proposal.

Unfortunately, due to heavy industry opposition, the proposal fell short of taking appropriate action, which would require banning inducements and establishing a professional group of truly independent advisors.

However, the proposal does contain measures that may improve the consumer experience. For example, the ban on inducements in sales without advice (for example, when consumers choose their own products online and only need an intermediary to follow through on their decision). Right now,  consumers do pay for advice even if they do not receive any, paying for a service they never received. Banning this is obviously the right thing to do. 

Decision-makers must now choose whether they want competition at the product performance level or if they want to support those offering higher commissions to sell the worst products.

There are other good proposals, such as the the ‘Value-for-Money’ system to be developed by European Supervisory Authorities to reduce costs of investment products. Without a ban on inducements, these interventions are necessary given that we have no functioning competition for product quality.

Decision-makers must now choose whether they want competition at the product performance level or if they want to support those offering higher commissions to sell the worst products. It is not possible to have both. 

Finding the right balance

Ultimately, to fix the broken retail investment market, we need to fix the imbalance between vested interests on one side and consumers on the other. Doing so will help establish genuine competition on quality and create more efficient and fairer market outcomes for consumers and society as a whole.