In 2012, the University of Minnesota conducted an experiment on its students.
A store on campus offered shoppers the choice between two special offers on coffee beans. They could either take 33 per cent extra free or get 33 per cent off the price.
Despite the unwitting subjects being degree-level students who were – you would hope – smart enough to spot that the latter represents a much better deal (as I’m sure you had all already worked out yourselves) the majority instead opted for the extra free.
The scientists concluded that this was a shocking indictment of the general populace’s maths prowess and underlined a fundamental inability to understand fractions and percentages.
I am sure that is the reason they viewed the two offers as equivalent and didn’t twig that they would be paying a 12 per cent higher rate. But, assuming the majority could not see the difference in value, what is more telling is the motivation behind them opting for the extra rather than the cheaper.
This decision is underpinned by a more basic fundamental truth – that we all love a freebie. Given a choice between saving a bit of money or getting something extra, we are all swayed by the promise of something for nothing, even if in reality it is more expensive.
It is worth remembering this fundamental flaw in human nature when weighing up the implications of two big and not unconnected stories from the past few weeks.
First, the news that Santander is reviving branch-based investment advice in a move anticipated to pre-empt a deluge of other banks following. This was followed days later by Tracey McDermott, the FCA’s director of enforcement and financial crime (and – more significantly – acting chief exec while a permanent replacement for Martin Wheatley is sought) telling Radio 4’s Moneybox that the regulator would “not rule out” the return of commission on investment advice.
It might seem that advice is reverting to 20th century models; it might be worth reminding ourselves why they were scrapped in the first place.
The appeal of commission-based product sales for individuals depended largely on the idea that they were getting something for free. The aversion to paying is broadly accepted as being the biggest reason behind the advice gap.
With commission, the masses were more likely to receive a level of advice than they are now.
And they could tell themselves it was free. The only problem was that it was anything but. Just because you don’t hand over any cash upfront does not mean you don’t end up paying.
And while more expensive than most consumers realised, the commission model was also detrimental to advisers, reputationally at least. Its very nature leaves all who use it open to accusations of bias.
Unless a system is introduced where each provider pays the same flat rate of commission, the presumption – whether accurate or not – will be that advisers are favouring providers who pay them more, rather than those who are the best fit for the client.