Are you looking for a financial planner or financial adviser? Who would you go to? There is no dearth of choices.
Let’s look at some of the common financial advisers/ planners/agents you may encounter:
- Mutual Funds Distributors (MFDs) or Independent Financial Advisors (IFA)
- Insurance Agents
- Bank branches/ relationship managers
- SEBI Registered Investment Advisers (SEBI RIA)
- Fee-only Financial planners
- Fee-based planners or those who link fee to assets under management (AUM)
- Those who ask to invest through a relative, friend or a related entity
Who would you go to?
Will you go to a fee-only financial planner or a fee-based planner?
Will you talk to a local mutual fund distributor or an insurance agent?
Will you go to your bank branch and seek investment advice from a relationship manager (RM)?
Will you talk to a Certified Financial Planner (CFP)? Or will you go to a SEBI Registered Investment Adviser?
Disclosure: I am a SEBI Registered Investment Adviser and work as a fee-only financial planner. I have vested interest in talking highly of SEBI RIAs who work as fee-only financial planners.
Honestly, the nomenclature does not lead you anywhere. So, you can’t rely on the names or the titles. Moreover, there is no official nomenclature.
For instance, Certified Financial Planner (CFP) is a certification in financial planning. However, depending on the business model, a CFP can be a mutual fund distributor or a SEBI Registered Investment Adviser (RIA). And that’s not it. A SEBI RIA could be a fee-only planner or fee-based planner.
Mutual fund distributors are also referred to as Independent Financial Advisers (IFAs). Terms such as advisor, planner or agent are thrown around without any discretion.
Sounds confusing, doesn’t it?
In my opinion, any financial adviser/ financial planner can be divided into two broad categories.
- Product sellers (and the advice is ancillary). Mutual fund distributors, insurance agents and banks fall in this category. They do not charge any fee but get commissions from financial services providers.
- Pure Advisors: Charge only for the advice offered and do not accept/receive any commissions from financial services providers. SEBI Registered Investment Advisers fall in such categories.
The problem with product sellers is that they will try to fit your requirements with the products they can sell, which is not always the best approach.
Moreover, product commissions can lead to a conflict of interest. A product seller may want to push products that earn him/her the best commissions. However, that may not always be the case. I am sure there are many brilliant MF distributors and insurance agents around. But you must stay away from banks.
Pure Advisors can handle a much broader canvass since there is no restriction of products.
Let’s look at different kind of financial advisors/planners on the basis of adviser/seller classification.
#1 Mutual Fund Distributors (Product Seller)
MF distributors are also referred to as Independent Financial Advisors (IFAs).
Typically, they will not charge you anything but they will ask you to invest in regular plans of mutual fund schemes. They make money through commissions from AMCs (mutual fund houses).
Remember commissions get paid from your money only. They get upfront commission and trail commission from the AMC. Hence, they make money as long as you stay invested.
Nothing wrong with that.
MF distributors can add a lot of value to investor portfolios, especially new investors. They can help select the right funds for you. They can guide you through times of turbulence too.
However, since the commissions are linked to the size of your investment, the commission can be substantial once your portfolio becomes bigger. When I say “substantial”, you can see the performance comparison of direct and regular plans of mutual fund schemes.
You need to see if the cost incurred by way of commissions is worth the value added. Never easy to make these judgement calls.
#2 Insurance Agents (Product Seller)
Insurance agents can help you with your insurance purchase decisions. Good agents can also help you/your family at the time of claims too.
However, there is a huge conflict of interest. Insurance commissions are front-loaded, especially so in traditional life insurance plans. Insurance agents make the bulk of the money in the first few years. It does not hurt them financially even if you stop paying further premiums.
Hence, unlike MF distributors, they have no incentive to make you stay invested. They have already made the money when you paid the first 2-3 commissions.
Another problem is that insurance agents can advise only insurance products. And insurance products never make for a good investment product. Since the introduction of tax on LTCG on the sale of equity funds, many insurance companies are actively promoting ULIPs for investment. In my opinion, ULIPs are still not good enough.
What should you do?
Do not mix insurance and investment. Most of the issues will automatically be taken care of.
If you want, you can seek assistance in purchasing a term life cover, health cover or a personal accident cover.
#3 Relationship Managers (RM) at Bank Branches (Product Seller)
Strictly avoidable. As I have mentioned in many of my posts before, bank branches are the worst places to seek financial advice.
Competence is also a serious problem with the banking staff. They are simply not trained to sell investment products.
The much bigger issue is that the bank officials just don’t care about you. All that matters to them is commission and their targets. They don’t care about you or your requirements.
Insurance agents, at least, have relationships to nurture. Banks RMs don’t have to do this either. Today, they are at ICICI Bank. Tomorrow, they will be at HDFC Bank. Or may be to a different branch within the same bank. As long as they can meet their targets, they don’t care.
You must go through this brilliant piece from Monika Halan, Consulting Editor, Mint. She cites an egregious example of mis-selling. An old man in his 80s approached a RM at a bank branch to open Senior Citizens Savings Scheme (SCSS) deposit. Sensing blood, he called in two of his colleagues.
Three of them convinced him to purchase a Unit Linked Insurance plan (ULIP). He was assured 14% return. The old man asked them if they would recommend the same product if he was their father.
All of us know their answer (Yes). Don’t we?
The old man invested in the ULIP and realized after a year that his corpus had gone down to Rs 4.11 lacs. Investment amount was Rs 5 lacs. Those three men were nowhere to be seen.
This was a ruthless execution of a devious plot. Though Monika Halan did not name the bank in her article, the modus operandi suggests it was a private bank. By the way, mis-selling happens at public sector bank branches too.
Did the old man in his 80s need insurance? The answer is most likely to be no. The bank officials sold the ULIP for a hefty commission.
Stay away from banks for financial advice.
#4 SEBI Registered Investment Advisors (RIAs)
Such advisers registered under SEBI Investment Advisers Regulations, 2013 are prohibited from accepting any commissions. They can only charge fee to their clients.
Since they are not allowed to accept any commission, the inherent conflict of interest is avoided. You are likely to be suggested products that you are best suited to meet your financial requirements.
You can read the full notification on SEBI website.
I recommend you to contact SEBI RIAs for availing any financial and investment-related advice.
All SEBI RIA may not work as financial planners. For instance, some of them may only be recommending direct equity to their clients. In such cases, the focus is to earn you good returns. They may also follow a very different compensation method. Whether the investments fit into your overall financial planning is something you need to figure out yourself.
In this post, when I talk of SEBI RIAs, I talk about financial planners.
Fee-only financial planner or Fee-based planner?
As mentioned at the beginning of the post, SEBI Registered Investment advisers can run their practice in multiple ways.
a. Fee-only financial planners (Pure Advisor)
Such planners typically charge a flat fee. The fee can increase gradually over the years. However, it is not linked to your assets under management/advice.
Fee-only planners do not get/accept any commission from mutual funds, insurance etc.
You will be advised to invest in direct plans of mutual funds schemes (instead of regular plans). This way, you also save on product commissions.
I have structured my practice as a fee-only financial planner.
b. Fee-based financial planners (Pure Advisor)
Such planners charge a percentage of your assets under advice as fee. So, if a fee-based planner charges 1% of your financial assets as fee and he/she is advising on financial assets are Rs 1 crore, you will be charged Rs 1 lac per annum as fee.
After 5 years, if the portfolio has grown to Rs 2 crores, the fee would be Rs 2 lacs.
Fee-based planners do not get/accept any commission from mutual funds, insurance etc.
They also ask you to invest in direct plans of mutual fund schemes.
c. Those who ask to invest through a relative, friend or a related entity (Both advisor and product seller)
There are RIAs who have continued their products (distribution/brokerage) business in the name of a family member or in a different entity.
So, they charge a fee from you and then ask you to invest through a specific entity or person. They will give all kinds of flimsy reasons for why you should invest through a particular person/entity.
Clearly, they are accepting commissions through different means.
In my opinion, such planners are following the SEBI Investment Adviser regulations only in letter but not in spirit. Essentially, they have managed to find a workaround by shifting product sales business to a family member/entity. In my opinion, you must avoid such RIAs.
Please understand SEBI does not define the term “Financial Planner”. There is no official term as “Fee-only planner” either. I have taken discretion in this matter.
What should you do?
Banks are a clear avoid when it comes to any investment advice. With Mutual Fund Distributors and insurance agents, you will incur a heavy implicit cost in the form of commissions.
I suggest you work with a SEBI Registered Investment Adviser (SEBI RIA). You need to see if you want to work with a fee-only or a fee-based planner. Invest in direct plans of mutual fund schemes. Avoid paying commissions.
Between a fee-only and a fee-based one, I recommend a fee-only planner.
How to choose?
Commissions, fee etc is one part. You also need to figure out if the planner/adviser is competent. Uma Shashikant did an excellent piece in ET Wealth. Here is what you should look at.
- You can find out about educational and professional qualification and experience.
- You can check out their websites and try to assess what the thought process is like.
- You need to talk to them too. Explain what you are looking for. Assess if the responses are cogent. The caveat is that most of them will sound quite persuasive.
- Does he/she sound honest? Does he talk only about products or the way you should think about investments or insurance? Does he focus on your goals or the products he advises or sells? Does he talk about the risks involved or merely build castles in the air?
- Ask him about the planning process and see if he can explain the rationale behind each step.
- You can ask for referrals but many advisers/planners are bound by confidentiality clauses. Hence, they may not be willing to share the details and for a reason. You may have to rely on client testimonials. LinkedIn can be a handy tool in such cases.
Not easy but you must do due diligence.
Disclosure: I am a SEBI Registered Investment Advisor and a fee-only adviser/planner. Hence, I have vested interest in asking you to avail services of a SEBI Registered Investment Adviser or a fee-only financial planner.