The Cost of a Poor Financial Product is much higher than the cost of Professional Investment Advice

I get many inquiries about financial planning or investment advisory services. During the follow-up discussion, a few prospects go cold once we start talking about the fees. I do not deny affordability can be an issue. A few perhaps feel that the advice (value) is not worth the price. I am quite finicky about who I onboard as a client. A few prospects are lost there too. Fair enough.

There is nothing wrong with this approach. Personally, I wouldn’t want to purchase things that I can’t afford. I also wouldn’t want to purchase something which I felt was not worth the price.

However, there are quite a few prospects who I feel really need professional help and can afford the fee but still don’t opt for the service. You can easily make out from the pattern of their investments that they could do better with professional advice. They have a track record of poor investments.  But still, they do not want to seek professional advice.

Why do they do that?

One reason could be that they do not think they have made bad investments. Or they might feel even though they had made poor investments, the cost of professional advice is still greater than the cost of poor investments. In my opinion, it is exactly the opposite.

What is the cost of investing Rs 2.5 lacs per annum for 15 years in a product that is unlikely to yield greater than 4-6% p.a.?

What is the cost of keeping Rs 25 lacs in a savings bank account (for no reason) and earning 4% on it while you could have made a fixed deposit out of the amount or invested in a liquid fund? Difference between earning 4% and 6% on Rs 25 lacs is Rs 50,000 per year.

What is the cost of a prolonged hospitalization when you didn’t see much merit in purchasing a health insurance plan?

What is the cost of financial and mental agony that your family may go through after your demise since you did not purchase adequate life cover?

I am not saying you can’t avoid these mistakes without seeking professional advice. Many can. However, if you are prone to making such financial mistakes, it is better to seek professional advice.

If you are concerned about the cost of financial advice despite repeating such mistakes, then you are simply being “Penny wise, pound foolish”

To begin with, we need to see why we end up picking up poor financial products. Let’s look at some of the reasons.

1. Many do not understand the financial jargon or the product details before purchasing

One of my relatives visited a bank branch a few years back to open a fixed deposit. She was looking to invest Rs 1.5 lacs in a tax-saving fixed deposit. We know how banks work.

Selling a plain vanilla fixed deposit is no fun. Plus, there is no commission income to meet sales targets. Hence, they sold her a unit linked pension plan. Needless to say, the insurer is promoted by a leading private bank. And the sale was done at the bank branch.

What she was told (or she understood) the plan to be: You need to invest Rs 2 lacs per annum for 5 years. After that, you will get a guaranteed pension of Rs 10,000 per month for life.

What the plan actually is: It is a unit linked insurance plan from a private insurer. She needs to invest Rs 2 lacs per annum for 10 years. However, she can discontinue paying the premium after 5 years. At the time of vesting (10 years) or when she surrenders the plan, she can withdraw up to 1/3^rd of the accumulated corpus as a lump sum and the remaining amount needs to be used to purchase an immediate annuity plan (at prevailing annuity rates). There is no guarantee of regular income since it is a unit linked plan.

Would she have invested if she understood what the plan actually was? I doubt that.

Would an adviser have helped? I believe so. Unfortunately, I was not an RIA when she purchased the plan. Still, if she had sought an opinion, I would have explained the plan to her and she could have made a more informed decision. I am quite sure that she wouldn’t have purchased the plan.

2. We evaluate the investment after we have made the investment

Many approach me after a few weeks after they have purchased a traditional life insurance plan. I call this an investment because that is how most of us look at it.

“I needed to save taxes. And I invested in an XYZ plan. Should I continue paying premiums or should I surrender the plan?”

Come on!!

Shouldn’t you have done the research before purchasing the plan? Unfortunately, that’s what most of us do when it comes to investments. We act before thinking.

If you surrender the plan after paying the first premium of say Rs 1 lac, you lose everything. To be honest, in some cases, surrender may actually be a good mathematical choice.

If you had sought professional advice before purchasing the plan, what would it have cost you?

If you had an investment adviser, whether to invest in the plan would be just one of the aspects of your financial life he would have helped you with

There is a heavy cost attached to selecting a poor financial product. You need to see if the cost of professional advice is greater than the cost of a bad financial product. Unlikely it is.

3. Searching for the Best Mutual Fund is NOT Research

That’s how most of us select the best fund to invest in. We type “Best tax-saving fund” or “Best mutual fund to invest” on Google and look for the answer. And it is not limited to mutual funds. We search for the best term insurance plan, best children plan or the best pension too.

I have seen many blogs that put out the list of best mutual funds (top 10) to invest in and such posts are among the most popular on those blogs with hundreds (and thousands) of comments.

Isn’t that how most of us do our Investment Research?

This is simply not enough. What might be a good investment for you may not be a good investment for me. A simple Google search will not do it for you. You need to select the right investments considering investment horizon, goal, risk profile, etc.

Moreover, in my opinion, selecting the right debt mutual fund is even trickier than selecting a good equity fund.  I get queries where investors are sitting on losses in a debt fund and they can’t fathom why. After all, debt funds are like bank fixed deposits. Aren’t they?

With equity funds, the mutual fund ratings can still be a good starting point. If you pick up highly rated funds, you should do well (there is no guarantee). By the way, “do well” means different things for different investors. To me, it certainly does not mean the best performing fund.

With debt funds, ratings can be quite unreliable. Even if you happen to invest in a 5-star rated long term debt fund during an interest rate upcycle, you are in for difficult times. Over the last couple of years, many investors rushed to credit funds (or the funds that invest in the lower-rated paper). Many of them have lost sleep over the past few months because of this decision.

I am not saying you should stay away from credit funds or long term debt funds (interest rate volatility). All I am saying you must not look merely at the past performance and must appreciate the overall risk-return profile and your goals before investing.

An investment advisor could have helped.

Does everybody need a Financial Planner?

Not everyone needs an investment adviser or a financial planner. You must decide if you need one. However, if you think you need one, get one.

Cost of professional advice will be much lower than the cost of making poor financial choices in life.

Not everyone is a Do-it-yourself (DIY) investor. There is nothing wrong in acknowledging if you are not one.  Not every one of us is a doctor or a surgeon. You don’t search for treatments or medicines on the internet beyond a point, right? If a round of home remedy or self-medication fails, you approach a doctor. Guess a doctor understands this aspect well. Not sure if this is one of the reasons why some of my best clients are doctors.

Price vs. Cost

I am sure many of us do not opt for professional advice because the price seems a bit too steep. Hence, we tend to seek advice from sellers of products, where there is an inherent conflict of interest. A salesperson will never speak ill of a product he/she sells. Please do note that the conflict of interest does not necessarily compromise the quality of advice.

The reason I brought up this point was that a few advisers will charge only a fee (and will not get any commission).  There are others who will advise you for free but will get a commission from your investments.

You may feel that the services of fee-only advisers are expensive (as compared to commission-based advisers). But what about the overall cost? You must focus on the overall cost (and not just the upfront price).

When we purchase any product or service, we look at the price of the product or the service. What we conveniently ignore the overall cost of ownership.

What would you rather purchase?

1. A car that costs Rs 6 lacs, gives a mileage of 12 km/litre of petrol and costs Rs 5, 000 per annum in maintenance. OR
2. A car that costs Rs 5 lacs, gives a mileage 8 of km/litre of petrol and costs Rs 35,000 per annum in maintenance.

You can assume cars are the same in all other aspects. Your decision will depend on how much you drive.  I am ignoring the mental agony (and time wastage) of taking the car to dealership/service center for repair/maintenance.

If you drive ~500 kms per month and a litre of petrol costs Rs 70, you will spend an extra Rs 17,500 per annum in the second car.

Including fuel and maintenance, you will spend an extra Rs 47,500 per annum in the cheaper car.

The choice is yours.  You need to see if saving Rs 1 lac per month is worth an excess expenditure of Rs 65,000 per annum.

What would you do?

Disclosure

I am a SEBI Registered Investment Adviser and have a vested interest in asking you to seek professional investment advice.

Image Credit: Winnifredxoxo, 2011. The original image and the information about usage rights can be downloaded from Flickr.