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.
Can you suggest some financial advisor in Dallas area?
Good points covered, some additions, a fee only advisor is a neutral identity, he will help you to understand your situation, understand your future needs, and ask you to fine tune your portfolio allocations. Yes, completely agreed that Fee only Advisor is not an alpha generator, his main role is to see whether his client is being too greedy for alpha or being too fearful due to risk, and help him have proper balance in his portfolio.
Completely agree on fee charging mechanism, however it’s an evolving process, hoping for the best.
Adarsh, it appears that you have not met a single Fee Only Planner and do not understand the Fee only Business Model. You are taking a strong stand against a business model promoted and regulated by SEBI and misguiding readers by directing them to approach intermediary who are not authorized by SEBI to advise Clients and have sullied the name of Adviser by advising products which are only to earn commission and not in the best interest of Clients.
There is misinformation in this article and that will keep away reader from revisiting.
Neeraj,
I am not advocating that you should not go with a Fee-only planner. All I am saying is, don’t blindly believe that just because someone is a fee-only planner does not mean he/she is good. Fee-only, like direct funds, is good when done right.
When you choose advisor, look beyond the tag of fee-only. That’s my argument.
And a counter question:
Person A- Fee-only advisor. Generates a return of 12% consistently for you. Good with communication.
Person B – AUM based advisor. Generates 14% return consistently for you. Takes 1% as fees. Just as good as Person A in terms of communication?
Would you still go with Person A?
Most people would not. That’s the point. Fee-only is not the only indicator of quality.
Thank you Adarsh for posting the response.
Agree that one has to do due diligence and pick the right Fee-only planner and that is true for any engagement.
When it comes to return, there is no comparative data available which indicates that AUM based Advisers are giving better risk adjusted return compared to Fee-only Adviser. If you have one, please share.
Please note that Fee-only Advisers are catering to 99% of Indians who are looking for risk adjusted return which can be beat the inflation on overall asset. The 1% investors are still living in the illusion that they will be able to beat the index return. The investors in developed economy have realized that and we will realize it soon.
The need of the hour is to simplify financial journey and life of Indian masses so that they can generate wealth which is good enough to live a life of dignity.
I am surprised how flawed your opening argument is and more surprised that no one pointed that out.
The store sales person gets commission from the store owner, not the customer. Of course that is a better model for the store owner.
So an equivalent conclusion would be that the commission based advisor is a good salesman for the financial products company whose product he is selling.
A client looking for an advisor is like the customer in the clothing store…. he is not looking for someone that makes sales…. he is looking for someone that will not sell the clothes if they dont fit him well.
Hi Shannon,
Thank you for contributing your thoughts.
The perspective I am trying to paint here is – if someone works for you, they typically will work harder if their financial incentives are aligned with making you successful. In the scenario listed in the article, if you are a store owner, people who work on commission will work harder for you – a store owner.
Now, coming to your argument that a retail customer is like a customer who walks into a shop to buy clothes. But that is the wrong analogy since you are not paying the salesman – you are paying the shop keeper. The salesman only has incentives to sell you whatever is there in the store – irrespective of whether it works for you or not.
None! Everyone wants to make that sale!
Now, coming back to the main point. I am not saying a fee-based advisor is bad ( I have repeated it enough in the article and comments). Towards the end, I do mention how to pick a fee-based advisor.
All I am saying is, just because someone does not have an incentive to sell you a product (distributors who also give you advice), does not make them a better choice (in this case a fee-based advisor).
Don’t ride the fad. Understand the pros and cons of each model and go with what suits you.