Financial advice for free or fee, what’s more expensive?
POSTED BY ON November 28, 2011 COMMENTS (21)
“Jo Cheez Free Mein Milti Hai Uska Paisa Kyon de Bhai?” said one person when his financial advisor asked him to pay a fee for advice, something which he has been giving free for the last 4 years. It may sound obvious that if you are getting something for free then why should one pay for it. But when it comes to financial advice, free can be very costly.
It is very common these days to hear about stories of investors losing money because of wrong financial advice. You can call it mis-buying of financial products or misselling or both. And while it is reasonable to expect every individual to gain enough knowledge before buying a financial product, I think a much bigger responsibility is upon the financial advisor to guide investors in selecting appropriate financial products. But many financial advisors have failed in protecting their client’s interest. Wonder why? Read on…
Conflict of interest
When financial advisors also sell financial products, it is a clear case for conflict of interest. The craving for misselling is higher when the advice is given for free and income is earned only from sales commissions. One important question for consumers of financial products would then be: “Will the financial advisor recommend me those products that are most appropriate for my needs or the ones that give him/her higher sales commission income?”
This conflict of interest, coupled with human greed has been cited as the main reason behind several global financial crises as well as the day-to-day mis-selling of financial products.
Separating advice from sales
Across the world, steps are being taken by financial regulators* to separate financial advisors and sellers. (*In India, RBI is a regulator for banking, SEBI for securities markets including the mutual fund industry, IRDA for insurance, PFRDA for pension products and FMC for commodities markets)
In healthcare, it is fairly clear that we go to a doctor for advice and then buy medicines from the chemist, so most people are accustomed to paying a fee to the doctor and then buying medicines from a medical store. It is also clear to us that if a doctor earns a commission from the sales of medicines or medical tests and surgeries etc, then the chances of getting biased advice are very high. The same logic applies to the financial services industry, however so far the distinction between financial advisor and seller has not been very clear. (Learn about our Financial Coaching Program)
In my opinion, the chances of an individual getting the wrong financial advice are several times more than getting wrong medical advice. Why? Because so far in India there is no regulation for financial advisors and that means that anyone can print a visiting card saying that I am a “Financial Advisor” or “Investment Advisor” or “Financial Planner” etc. There are no mandatory educational qualifications, experience or registration requirements. But things are about to change!
What the financial regulators in India are proposing
The financial regulators in India are working towards regulating financial advisors. Regulations will include a minimum educational qualification and registration to get a license for becoming a financial advisor. It will have a set of rules laid down for advisors and any misconduct can lead to a penalty or even revocation of their license.
SEBI, in its concept paper for the regulation of investment advisors, has proposed several steps to separate investment advisors from investment product sellers. One of the things proposed is that all professionals who want to call themselves ‘advisors’ should not take commissions from financial product manufacturers and their income should come from the fee that they charge their clients i.e. investor.
If advisors will have no commissions to earn, their advice will remain unbiased and they would represent the interest of their clients and not of the product manufacturer. This is termed as a fiduciary relationship. Clients would then have to pay advisory fees to the advisor based on the value received. Financial product distributors or sellers who offer transaction execution and related service can earn commissions, but then they will not be able to call themselves as advisors.
So for a common man, differentiating between a financial advisor and distributor will be made easier. Here are a couple of related articles in the financial media: Sebi to come out with guidelines for investment advisory space and SEBI certificate must for investment advisors
Fees v/s Commission – does it make a big difference?
I think many individual investors resist paying fees and don’t really bother about how much commission their financial advisor or agent earns because they feel that “It is the financial product company (e.g. mutual fund or insurance) that is paying commission to the agents/advisors, so why should I care?” Well, actually it is the investor’s money from which the commission is paid! To understand this better, have a look at these two presentations on Why did SEBI Abolish Entry Loads in Mutual Funds? and How to evaluate your financial advisor.
There have been some anxiety and concerns amongst an existing lot of financial distributors and advisors. Their biggest fear against this regulation is that “consumers are not ready to pay a fee for advice, so we have to live on commissions.” Some of these concerns are valid and hence the new regulation has to be supported with adequate efforts on investor education and awareness.
What is the way forward?
Some really important developments are going to happen in the near future that will significantly impact financial advisors as well as individual investors.
In my personal opinion, regulating financial advisors will be beneficial for both – investor community and the financial services industry. However, it will be very important to implement the regulations in a consistent and phased manner with adequate investor education. By consistent, I mean that coordinated regulations should come across all products i.e. mutual funds, insurance, pension products, etc. So it should regulate financial advisor and not just investment advisor, thus encouraging holistic financial planning. The good news is that multiple financial regulators are collaborating on this effort of regulating advisors and we can hope for a comprehensive regulation.
Along with regulations of financial advisors, it will be very critical to conduct an awareness drive to make people sensitive to the fact that paying fees to a financial advisor/planner are more transparent. This shift in perception is very important otherwise many honest financial advisors will have a tough time running their practice and many consumers will be deprived of good financial advice.
Also, I’m not saying that paying fees for advice is any guarantee for getting good advice, you may even get very valuable advice for free from a friend or you can educate yourself enough to be your own financial advisor. But if financial advisor as a profession has to grow and mature, then I think a consumer paying fees for advice is much more transparent than the commission-based model which has an inherent conflict of interest.
Are investors fully aware of this critical issue?
In my professional experience spanning over 14 years, I have had the privilege to work closely with various banks, asset management companies, stockbroking and distribution houses, independent financial advisors, insurance companies, media houses and financial regulators in India. So when SEBI made the concept paper for regulating investment advisors open for public comments in October 2011, I interacted with various stakeholders on this issue to get their opinion.
And I realized that while the financial industry is abuzz with discussions these developments, there was hardly any discussion happening amongst the investors and consumers of financial products. Most of them are not much bothered about this issue of fees and commission. So I thought it was important to write about this issue with an objective to give individual investors a viewpoint that would help them in working with their financial advisors. Many good, honest financial advisors are today facing a lot of challenges in sustaining their business and convincing their clients to pay fees for advice, service, etc.
And many myopic financial advisors are going around finding newer ways to misguide their clients under the garb of being their trusted financial advisors or ‘relationship managers’. Hence it is important to take an informed and balanced view on this. We have also created a website – http://wikipaisa.com to spread more information on this issue of Free v/s Fee for financial advice.
I’d like to take this opportunity to know your views as an individual. Do you currently pay a fee for advice? And if not, do you think it makes more sense to pay fees? Or do you think the current model of the commission structure is fine? If you are an advisor, do share your feedback too, but please mention in the comments that you are an advisor. So do share your views and also answer this poll question.
This is a guest post by Deven Shah, who works as a Consultant with the National Institute of Securities Markets (an educational institution established by SEBI) and has played a key role in initiatives like InvestorFirst.in, The Pocket Money Program and CPFA Examination. All views expressed in this article are his personal opinions and do not represent the views of any organization he is associated with. He also leads WikiPaisa – a collaborative effort to make money simple and live happier. He can be reached on deven@wikipaisa.com
Dear Manish,
Is there any investment plan which doesnt give any life insurance… means pure investment (except FD, PPF,NAC etc.)
Mutual Funds, ETF , ULPP’s , NPS
Actually I did a term policy for 1 crore now I want invest my money for a better return. for which should i go for a better return ?
Invest in Mutual Funds
Being a CFP^CM Practitioner, I think this write up is very useful for investors. I think he who takes free financial advice is looser instead if he pays fees he can use his hard earned money and his money works for him. Time will speak.
Uttam
mnost of the people do not think like this . Even I dont agree that paying fees is the last resort .If one can take out some time and has committment, has can do basic planning .
Manish
Manish,
Good article..and nice points raised too..
Let me put some thoughts from the OTHER SIDE..allow me to start with your example of a MEDICAL PRACTITIONER (Doctor as we say). A patient goes to the doctor, doctor diagnose him, advice him some medication which the patient goes out and buy from the chemist..END OF THE TRANSACTION..PERIOD..If the patient is not cured within next few days, can he say that he has been MIS-SOLD or wrongly adviced?? and everybody knows that why do a doctor always advise patient to go to a particular DIAGNOSTIC CENTER for tests and write such peculiar medicines which are avilable at certain specific CHEMIST?? And as you write above, anybody can say I am a FINANCIAL ADVISOR unlike medical practitioner, the fact is there are lakhs and lakhs of QUACKS (Jhola-chaap doctors) sitting in every nook and corner of our country, posing a severe hazaard, not only to their money but as well as to their LIVES..So that paints a doctor in bad light?? I dont know how anybody takes this point.
And now to the second point. A layman investor, as SEBI is now trying to put, will pay an X amount first to the FINANCIAL ADVISOR as the FEES and then when he will purchase the product from the DISTRIBUTOR or SELLER, he will be paying Y amount as COMMISSION to them..As of now he is paying X amount and after this formula, he will be paying X+Y amount..Does it make sense?? to me, NO..
Moreover, how will Mr ADVISOR say that whatever i am advising (buy good LARGE & MID CAP FUND – preferrably HDFC TOP 200) is the BEST..It may be good according to his judgement but just like second opinion in case of Doctor, if someone goes to another ADVISOR and he says something contrary, will that make first ADVISOR look like a fool?? Dont know..
Me being an INSURANCE/MEDICLAIM/MUTUAL FUND advisor takes the entire responsiblity as of now for whatever investment the client has made on my say. From now on, Mr ADVISOR will wash off his hand saying, “I just adviced you, not sold you anything” and Mr DISTRIBUTOR will say that, “I sold you what you have asked from me.” to me, it would be a FUNNY situation as the client will not be able to hold responsible anybody for his investment..
..and the MOST IMPORTANT aspect is that INSURANCE etc are all PUSH products, not only in INDIA but all over the world..Any fine day, Mr Rahul or Mr Prem would wake up and say that today, he is going to buy a SHIRT, JEANS, SHOES, BIKE, CAR but nobody in my career of last 5 years have asked me to give them INSURANCE POLICY. Every time, its me who is to go and sensitise or awaken them about their needs and how to bridge the gap..And despite all this, i am considered either the MOST GREEDY GUY (Selling only for COMMISSION) or USELESS GUY (Ye nayi cheez kya bataiyega, sab kuch to TV pe ya NEWESPAPER main mil jaata hai)..
Another point, as raised in this thread is INVESTMENT..Most of the CFPs over here would agree with the INDUSTRY DATA that average age of a SIP in indian mutual fund industry is 18 to 20 months..Nobody is willing to run his investment the entire course of 10 to 12 years..So how would i be benefit from COMMISSION anyway?? Should’nt there be a penalty on the INVESTOR as to breaking up the investment prematurely?? Wrong thinking this on my part, i believe..But that is how it works here. Client is not ready to pay me anything (are you kidding?? paying you for advice?? i know Mr Gupta in neighbourhood who pass back 50% of the commission) and then whatever commission i am getting is not FOOLPROOF, because i dont know when Mr A will stop his investment in any SIP?? For me, there are no lunches at all, let alone free..
All these changes are good if done partially and steadily, not suddenly and thrust upon everybody (especially INDIVIDUAL FINANCIAL ADVISOR). Big banks, who are real distributors are real winners any which way..They will have two CUSTOMER RELATIONSHIP DESKs now, instead of earlier ONE. ONE desk where Mr ADVISOR will sit and advise you to buy HDFC TOP 200 and RELIANCE GROWTH FUND and the SECOND desk where Mr distributor will be sitting with forms of HDFC MF and RELIANCE MF..
I know my views are different but you can take them as plight of an IFA..
Dhawal
I am with you on all the points raised from IFA point of view .. the current draft is still in discussion phase and i agree that there has to be proper time to be given to IFA to make the transition
Manish
Dhawal,
Thanks for a detailed response. I was travelling and hence the delay in replying. Here are my thoughts:
Also, I think we have to give a good chance to the ‘pull’ factor. If really simple and effective products are offered along with raising the right kind of awareness, financial products can become something which people buy and they might not necessary need hard-selling. In the next 3-5 years, we can see a growing trend of people buying online term life insurance, Mutual Funds etc. directly without any push. And when things become transparent, the actual X+Y amount an investor would have to pay will not be more than X amount he/she might be paying/losing currently.
I think every ‘financial advisor + distributor’ has to take a call now on what are they best suited to be – an advisor or distributor and focus on that one thing. If you are fully convinced about the value you add to your clients with your financial advice, then you can convince your clients to pay fees. It may be a tough journey initially, but eventually you will find a way. But if you feel that you are much better at selling, then you should focus on becoming a distributor and think of expanding your business in that direction. There’s nothing wrong in doing business as a distributor.
My sense is that from the current lot of ‘advisors + distributors’ some will go for advice-only model, some will go for transaction-only model and some would still continue doing both. So, I fully agree with you that it would be much easier for large banks/distributors to put two desks in the same branch where one advises and other sells. For IFA’s and smaller entities, the transition would be more challenging.
Personally, I agree that it is becoming difficult for IFAs to adapt to the pace of regulatory changes and I’m actively interacting with IFAs to understand their challenges. I think the best option is to think positively and find solutions. In a few weeks, I’ll update you on some suggestions/ideas to help IFAs in running their advisory practice successfully.
Regards,
Deven
Hi Deven,
Good one.
So you have to invest to earn, either in terms of your time to learn or as Fees to advisor. There are no free lunches 🙂
Regards
Shobha
Absolutely. Free lunches can cause ‘Delhi Belly’ 🙂
Good one Deven. Some choose to pay the fees and some choose to pay the price. It is a choice that every investor makes.
Looking forward to more such articles from you.
Sure, Nandish.
A lot of people realize the value of good advice once they bear the cost of bad advice. I’ve tried to explain that part here: http://wikipaisa.com/right-to-credible-financial-advice/value-good-advice/
Thanks for sharing the link. Good advice is what makes a real difference.
Dear Deven,
My sincere thanks for writing on this issue in detail.
I am a CFPCM certificant based in Nashik and will be amongst the first ones to congratulate SEBI, if proposed meaures get implemented. We, as an advisor will have an upperhand in deciding which product/s is/are to be chosen for the investor implying that commission agent will play execution role only.
Regards,
Aditya
Dear Aditya,
Glad to know that you are looking at it positively. And whether regulations comes now or later, I think financial advisors who haven’t yet started charging a fee to their clients should move towards it now and reduce/remove dependence on commission based income.
Regards,
Deven
Swaka, Mahavir:
I’m glad you found the article useful.
Siddhant,
In the Mutual Fund industry, an agent/distributor can anyways sell schemes from multiple funds. Can you please expand upon your question please?
well, the agent has to go through empanellments with all the MF & the commissions are dependent mostly on personal relations kept with individual agencies, where is the incentive to give independent advise without thinking about the personal relations? Broker on the other hand can get better deals from MF industry as a whole & can ask some questions which empanelled agent will not be able to work, effectivelly speaking the broker has more incentive to work for consumers but current MF commission set up incentivises good relations with MF copanies
Siddhant,
A facility that would help customers, distributors and financial advisors transact mutual fund schemes across all AMCs at one place is underway: http://www.business-standard.com/india/news/amfi-to-launch-mf-platform-next-year/451203/
Manish,
the question to be asked to the Regulators is why is there no MUTUAL FUND BROKER in MF industry like insurance, who can give advise without worring about the commissions as the industry will have to pay commissions based on similar lines of Insurance brokers
nice informative article