10 years ago, in 2005, I had purchased a unit linked insurance policy (ULIP) sold by an agent who did not charge me for the service. It appeared to be the best deal that I could get – get free advice, get insurance worth Rs 7 L, and after 10 years get returns with an expected rate of 10%. Why 10%? Because the financial markets had then soared up 100% in the past few years, and 10% was a very ‘conservative’ estimate. I had planned for a Caribbean trip. But, now, in 2015, all I can do is to regret my decision of buying the ULIP. Having kept the product for a “long term”, the results have been disappointing. The returns of the policy are less than the cumulative premiums that I had paid for the past decade. I would got better returns by merely keeping the premiums in a savings bank!
But when I look at the fund’s performance report, the graph is mostly up. So where did my money go? Most part of my premiums (ie upto 50% of my annual premiums!) that I paid for the first five years or so, went to the agent who sold the policy. The remaining part, a minuscule sum of money, was being invested in the financial markets. Hence, while the fund tried its best to beat the market and inflation, because I had already lost 50% of my investment to commissions, my returns are in negative. Or to say, the free advice rendered by the agent was not free, rather, it was a decision where I paid, at least, Rs 20,000 to the agent to get a loss making financial product. That agent could have easily sold 100 such policies and must have enjoyed a grand Caribbean trip.
Looking back, there were many things that went wrong – first, my knowledge of the financial markets was limited. Investment in any product should have been done with a comprehensive or holistic outlook of future financial requirements. Second, the laws of the land and regulations were slow to react to mis-selling of financial products. Third, unbiased guidance on investment, apparently, did not exist. Like me, many others have lost hard earned money due to commission based ‘free-advice’ selling and helped fill up the agent’s pockets.
A lot has changed in the past decade, especially in the last 5 years. Information boom, thanks to Social Media and cost effective electronic devices, has enabled investors to get information on financial products. Financial bloggers, launched in early 2010s, have now become famous and help investors take corrective actions.
SEBI (Security Exchange Board of India), regulatory body of the financial markets, has introduced from time to time, several measures in favour of the Indian investors. In 2013, SEBI introduced the Registered Investment Advisor (RIA) regulations, where only a person/firm/corporate that is registered as an RIA, can give financial advice pertaining to securities including financial planning. This strict regulation eliminates several self-proclaimed experts, and also lays the foundation of a type of financial advisory popular in the Western world – fee only financial advisory.
As an RIA, the only source of advisory income will be the fees charged to the investor. The financial advisor would assess the investors risk appetite and then suggest several financial products, ranging from insurance, mutual funds, PPF etc, as a cohesive set of products that will help the investor create wealth. Wealth has never been created with financial products purchased in silos. Assessment of income, expenses and savings combined with the financial goals of an individual or a family would be evaluated before providing investment suggestions. The advisor cannot sell a financial product for commissions, and if the advisor does so, she/he could face penalties from SEBI.
Unfortunately, in India, a financial advisor is often confused with a relationship manager (RM) of a bank, where one holds a savings account. Such RMs are again commission agents. Nothing comes free in the world, and RMs employ several tricks to eat into your investments. If you get regular ‘free advice’ from your RM to switch funds, then you are a victim of churning – a method employed to get the 1% or 2% exit load when funds are redeemed before an exit load lock-in period. Ie if you have an investment of Rs 1Lakh in your mutual funds, and your RM switches the funds regularly, then about Rs 2000 is your annual loss for each switch. Churning also helps the RM to get additional commissions since a new purchase is always rewarded to the agent. Hence, free advice always lands up in loss making financial products, which benefits only the commission agents.
Fee only advisory is growing slowly in India, and apart from more stringent regulatory norms – with the rising income levels, increased jobs in the private sector, a shorter employment period (retirement does not have to be at 60), busy work life schedule, double income family, heavy debt (thanks to that home loan) – the right financial advice, even if taken once, will help a family grow wealth, and hence achieve the their goals and dreams! So if you have a Caribbean trip planned, then better connect with a fee only financial advisor and get your financial assessment and goals right. Most financial advisors charge Rs 12,000 to Rs 20,000 for a yearlong contract, and as per an estimate, fee only advice could generate an additional Rs 70 lakhs if they execute a financial plan via an RIA. More importantly, in fee advice, you get financial products that you need and not the other way around!
Authour, Krishna Rath is the co-founder of finvestor.in, a listing site for SEBI Registered Investment Advisors, and a financial knowledge website. He along, with co-found Rahul Malewar, are attempting to ensure that investors in India get the best financial advice.