Is the illusion of ’free’ financial advice costing you more in the long run?

Recently, the capital markets regulator, Securities and Exchange Board of India, proposed changes to make it easier for individuals to become registered investment advisors (RIA) for individuals looking to get advice on their personal finances.

SEBI has done this, presumably, with the objective of encouraging more professionals to seek out the RIA licence. The current set of conditions for this have a very high entry barrier in terms of educational qualifications, experience and net worth requirement among other things. The distinguishing feature about RIAs is that they earn from fees charged to clients and are not commission-based agents earning from product manufacturers like asset managers or insurance companies. This facet of how they earn, enables an alignment of their compensation with the advice given to clients, minimising the conflict.

While RIAs have an advantageous fee-based proposition for investors seeking out unbiased financial planning advice, the interest in this profession is kind of stagnating. The other option for financial planners and advisors is to be agents of the manufacturing company where they earn thanks to a commission paid out for every sale. While conflict is not a given for distributors and agents, the incentive is there and hence, the onus is on the investor to ascertain whether the advisor can be trusted for objectivity and working in their favour or not.

Intuitively, shouldn’t investors themselves demand and seek out more RIAs? Afterall, a regulator approved and registered advisor who has to follow guidelines that effectively minimise the conflict in the advice given to investors, seems to be the more relevant choice. 

Anecdotally, however, we know that this is not the case. There may be many factors that can be attributed to why investors don’t actively seek out the help of SEBI registered investment advisors. What we do know is that one of the most common hurdles such advisors face is the unwillingness of investors to pay fees.

The fee hurdle and the free lure

Typically, the fees charged by RIAs are apportioned as a percentage of assets under advice or a flat fee. For commission-based advisors, the earning is an indirect fee and comes from the manufacturer and this cost is embedded in the product price itself.

In the case of the RIA the fee is thus very visible and the investor herself needs to pay it. Whereas, in case of the commission earned by distributors, it’s not so apparent and unless it’s enquired about specifically, the investor may feel that the advice they are getting is free. In fact, the fee is embedded in the annual cost of the product which is adjusted in the daily price of mutual fund schemes and in case of insurance, it’s deducted from the premium paid. But investors do not really see the cost at all.

While the economic consequence of both options may be similar for the investor, it’s been shown through various surveys and scientific studies that people do not like to pay upfront fees for services such as financial advisory. They expect to get it free. No wonder the RIA is getting ignored by investors.

When you walk into your local bank branch and they offer you investment advice without your having to cut them a check for fees or transfer any amount as their advisory fee, it feels like that advice is free. However, there really is no free lunch. They are getting paid by the product manufacturer through commissions that come from the embedded cost you are paying for the product. 

In fact, this kind of earning can have a lot of conflict and where the intent is to maximise their own earning, even your bank relationship manager may be tempted to sell you financial products that are not useful for you in any way.

Look at rationally, you will understand it but when the word ‘free’ is added to a service, all rational thinking gets thwarted. There is a new bank advertising ‘Zero fee banking’. Think about it, if they don’t charge you fees, how will they make money and if they don’t make money how will they survive? It’s not an NGO, it’s a bank.

What doesn’t get charged upfront, is often embedded in cross selling products or as other fees and costs which you won’t be aware of.

Another lure is ‘return of premium’ term plans, which make you feel like you are getting a term life insurance policy for free. But if you see the details, the premium itself is a lot higher and by the time it is returned to you, the insurance company would have earned a neat float on the amount.

Nothing comes for free. It’s a reality we are most reluctant to embrace, because getting something for free feels good. Bakeries and sweet shops often reduce prices or have deals like buy one get one free towards the end of the day, simply to ensure that the freshly made items don’t go to waste. So, you will get something free if you wait till the end of the day to buy it, however, by now the quality (freshness) of the product has already deteriorated somewhat.

Financial services and advice are not perishable. It’s really the opposite. If you are seeking sustainable, high quality and reliable advice that is personalised to your unique financial needs and circumstances, you must pay for it appropriately. If you are just chasing the next new trend in investing, then you can follow the herd for free. While the former will help you create wealth over time, the latter is risky and comes with a fickle crowd that can change direction too quickly.

You decide whether you want financial advice for free or you want sustainable quality and results at the right price.

Lisa Pallavi Barbora is a financial coach and founder of moneypuzzle.in