There’s a new trend in the financial industry – fee only.
The financial industry is not known for values. It’s known for snake oil salespeople who will sell you anything for a commission.
And no, I am not talking about the uncles and aunts in your family who are LIC agents. That’s a story for another day.
Capitalizing on this belief, a new trend has emerged – fee-only financial planners.
What’s the pitch for a fee-only model?
The value that a fee-only advisor brings to the table is that they are unbiased. Since they do not get commissions from products that they recommend, they can have your best interest at heart.
For a fixed yearly fee and a subsequent retainer fee, a fee-only financial advisor will recommend you the best course of action for your investments.
The problem I see with a fee-only model – Zero incentive
Imagine that you are a clothing store owner.
- Scenario #1: Your salespeople work on a commission model. They take home a percentage of the total sales they make in a year
- Scenario #2: Your salespeople work on a fixed-fee model. Irrespective of whether you sell 0 clothes or one-lakh clothes, they get paid the same
Who do you think would harder for you?
No points for guessing the people working on commission will work harder. They have skin in the game. The make more money when you sell more and they make less money when you sell less.
Now, apply the same principle for fee-only advisors.
They stand to make the same amount of money whether you make 50% profits or 50% loss.
Yes, they do not have any incentive to sell you the product which offers the highest commission. However, they do not have any incentive to ensure you make you money either.
So the argument is kind of mute.
The biggest problem with a fee-only advice – The need to do something
Sure, there is lack of incentives. But there’s something far bigger.
Most Indians are averse to paying any sort of fee for financial advice. They’d happily spend Rs 5,000 for a single night partying with their friends in a pub. But the same person will consider it expensive to pay Rs 1,000 per year for solid financial advice.
Now, imagine a few years when the markets are steady. The only solid advice your advisor can give you is – keep investing in the same products. There is nothing else you need to do.
Maybe year 1 is fine. But would you be fine paying someone when all the advice they are giving you is – “keep doing what you are doing”?
People have a problem rationalizing the need to pay for advice. When the advice is “nothing needs to be done”, most people will pull the plug on paying an advisor.
How do advisors stay relevant? How do they prove to a generation of people who think they don’t need advice, that it’s worthwhile paying for?
This brings me to the biggest problem – the need for the advisor to do something.
Your advisor needs to prove to you that they are doing something. So they would recommend a few trades once in a while to ensure that you get the impression that there’s active involvement.
Over a couple of years, you’ll either end up with dozens of products you should not have held in the first place. Or, you will end up paying a lot of taxes moving in and out of products while realizing capital gains.
Taxes are a bigger problem now considering the re-introduction of the Long Term Capital Gains tax on equity investments.
The business model for fee-only-planning is broken
As someone who has run multiple businesses, I know a thing or two about ensuring cash flow to ensure a business survives.
As much as what every advisor would like you to believe, they are not in this business to make you rich. Nor do they really care about ensuring you have a great retirement.
Advisors see someone needs help, they have a skill they can make money from, so they offer you a service.
Every advisor runs a business that needs to make profits.
Look at most of the fee-only financial planners and they’ll have 2 plans – one for resident Indians and a slightly higher plan for non-resident Indians (NRIs). There are no other plans!
How do you service a client who has 1 lakh available for investments and another who has 1 crore in investable assets with the same fees? You might receive a huge inheritance. Or you might have a unique financial requirement that needs a lot more attention.
From a business point of view, it makes no sense to charge everyone the same. Some would even say it’s unfair. That being said, some advisors do have a tiered plan. If you are an advisor with a tiered plan based on the effort involved, kudos on your business sense.
How should I hire a financial planner then?
No one other than you, your spouse, your parents, or your children will usually have your best interest at heart. The best solution is to learn the basics of investing and invest yourself.
But I know that’s easier said than done. I am someone who invests in mutual funds because I do not have the time to sit and research stocks. Even if I have time, I’d rather spend time with my family than spend hours every week following the news. I certainly don’t want to spend time going over company balance sheets to identify “value stocks”.
If you’d rather have someone else do it, choose an advisor who has a solid investing track record. Don’t go with the cheapest person you can find. Go with someone who:
- Takes on limited clients
- Proactively communicates with you
- Doesn’t nudge you to try out the newest product in the market
- Doesn’t promise you returns
- Does not sound too good to be true
- Has a solid business model
What do you think?
Do you have any experience working with a fee-only financial advisor? Or are you happy with your advisor who works on a commission basis? Let me know your thoughts in the comment below.
“How do you service a client who has 1 lakh available for investments and another who has 1 crore in investable assets with the same fees” why does that matter? They charge the fee to develop a plan and suggest ways to invest for a person, but is it very hard to develop a plan for 1 crore and very easy to develop a plan for 1 lakh? effort-wise both are same, and in-fact they charge the fee based on the effort required to develop the plan (if the investor doesn’t have one).
This single point makes me think that you are biased against fee-only advisors. Many advisros charge about 10k+ for 1st year because they need to develop plan and later years only about 2-3k per year, because it is just reviewing the progress and rebalancing.
Hi Ravi,
Thank you for your comment.
The point you seem to be making is – “Irrespective of the assets someone might have, the effort to service the client is more or less the same.”
I beg to differ.
As someone who has built investment products for the average investor as well as HNI clients, I can confidently say that the effort required to support these are very different.
HNI clients usually need high touchpoints – either due to the Indian mindset that if you are rich, you deserve special treatment or due to their complex financial needs. Especially the latter.
Think of a typical HNI in India. They might usually be 45+, have kids, have a variety of assets – real estate, businesses they own, stocks and bonds, etc.
Compare that to a 30-year-old average Indian who might have less than ten lakhs in savings and possibly no assets like home (Not yet inherited, or not yet bought).
The goals will also be very different for these individuals.
Coming to the main point – My argument is not that fee-only advisors are bad. It’s just that because someone is fee-only, that does not automatically make them better.
Fee-only advisors should charge based on effort – not based on a simple classification like NRI/Non-NRI. This way, they will have a sustainable business.
Otherwise, the retainer they get from me will be too small to matter to them. They will run after new clients all the time.