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When we are unwell, we consult a doctor, take a prescription, and then buy medicines from a chemist.
In finance, too, it is best to keep investment advice and product purchase separate, suggests Bindisha Sarang.
Many people suffer from overconfidence bias -- the tendency to believe we are better at something than we actually are -- when it comes to managing their finances.
Those who have full-time jobs or run a business lack the time, the energy, and sometimes the inclination to manage their finances.
Many don't possess the requisite knowledge.
Several behavioural issues, like loss aversion, also creep in when making money-related decisions, further hampering the ability to do a good job.
When the odds are so heavily stacked against us, the best thing to do for most investors would be to hand over the charge of managing their personal finances to an expert, such as a Securities and Exchange Board of India-registered investment advisor (RIA).
In reality, few people do so. According to the DSP Winvestor Pulse 2022 survey published recently, of those surveyed 40 per cent men and 27 per cent women make investment decisions without consulting a professional advisor.
This was an online survey, which tilts the sample towards more educated and aware people.
The percentage of people who don't consult a financial advisor would perhaps be higher in an offline survey.
RIA versus MFD
An RIA is a person or an organisation permitted by Sebi to provide investment advice.
RIAs have a fiduciary duty towards their clients to offer financial advice that is in the latter's best interest.
They don't earn a commission from the products they recommend.
Their clients pay them a fee, and hence it is in their interest to act on their clients' behalf.
Says Avinash Luthria, founder, Fiduciaries.in, an hourly-fee financial planner and Sebi-RIA: "It is easy for the client to stop paying the fee if he is not happy with the service."
Mutual fund distributors (MFDs), whose job is to sell mutual funds, are registered with the Association of Mutual Funds in India (Amfi).
Their remuneration comes from the commissions they earn from the sale of mutual funds.
When we are unwell, we consult a doctor, take a prescription, and then buy medicines from a chemist.
In finance, too, it is best to keep investment advice and product purchase separate.
"Products are not always the solution to the needs of investors," says Dilshad Billimoria, board member, Association of Registered Investment Advisors.
Buying mutual funds based on an MFD's recommendation can be risky.
Says Colonel Sanjeev Govila (retd), a Sebi-RIA and CEO of Hum Fauji Initiatives, a financial planning firm: "When the advisor's compensation comes from the product, there is always a chance that the products he recommends will be coloured by the compensation he receives from them."
The annual commission MFDs get from some schemes can be as much as 10 times the amount they earn from others.
That creates a temptation to push products that pay higher commissions.
Says Luthria: "MFDs could favour equity funds over debt, active funds over passive, sector funds over flexicaps, small cap funds over large caps, credit risk funds over liquid, and schemes of fund houses that have an aggressive sales approach and higher commissions. But many products that pay a higher fee could carry more risk."
An MFD may be offering funds from a limited number of fund houses. He is likely to push those. This could affect the client's portfolio quality.
An MFD may also not do a detailed study of the client's financial goals and risk profile, and instead focus on the ad hoc sale of products.
"A poor start in terms of product selection and portfolio construction can lead to disastrous outcomes," says Billimoria.
Flat fee or AUM-based?
RIAs charge either a flat fee or a percentage of the client's asset under management (AUM).
A flat annual fee is fixed by mutual consent between the investor and the advisor.
The percentage of AUM can range from 1 to 2.5 per cent. A handful of RIAs charge on an hourly basis.
RIAs charging fees linked to AUM might be tempted to prevent you from reducing the AUM.
For instance, they might advise you to not liquidate your funds to pay high-interest debt, as this would reduce their fee.
Choose a flat fee or percentage of AUM model based on your affordability, the workload for the RIA, and the value you get in return.
"Be clear about why you require an advisor. The fee structure should depend on the kind of advice you seek. Go to someone who you think will provide you with a solution," says Harsh Roongta, founder of Fee-Only Investment Advisors LLP, a Sebi-RIA.
It's akin to choosing a doctor
Choose an RIA based on his knowledge, reputation, experience, and fees.
"It's like visiting a doctor who has the required qualifications, experience, and competence and will provide unbiased advice which is in the patient's interest. Make sure the advisor ascertains the overall situation before giving advice. He should provide comprehensive goal-based financial planning," says Billimoria.
Several MFDs said off the record that some RIAs make their clients buy mutual funds on commission basis from an MFD relative. Avoid them.
When to switch
Watch out for a few red flags. "When the advisor churns your investments often, it's a sign he is earning commissions from products," says Billimoria.
Also avoid one that promises high, market-beating returns.
Change the advisor when you don't get the expected value addition.
Adds Govil: "The fee charged could be very high, not commensurate with the quality or range of the advice given, or the advisor may be handling too many clients."
