How many times have you got a call from someone claiming to be from a big mutual fund advisory company or the credit card department of a bank pushing their products?

Stop right now!

I hope you do know- THEY LIED TO YOU.

As a matter of fact, regulated mutual fund advisory, insurance, banks etc. cannot indulge in unethical marketing practices like cold calling, spam messaging and emailing.

I’ll tell you the guys who can – intermediaries who work on commission.

Cold Calling: If your investment decision started with you receiving a cold call, nothing can undo the damage already inflicted to your portfolio. While it is always a good idea to do social good, trust me when I say this: nobody is interested in helping others at the cost of being insulted over a phone call.

The bigger worry of cold calling however is this – you are almost certain to be dealing with someone who has been tutored to speak based on marketing inputs and has little understanding of investments. In short, call center departments invariably turn into conveyor belts for young college grads who are asked to talk a certain line – in 8 hour shifts a day!

Commissions – What You Should Understand

Mutual fund companies, banks, insurance companies all pay commissions to get more business. The rate of commission differs based on products. As an investor, particularly in India, advisors and distributors are often looked upon with some degree of suspicion. The belief system is that they will try to push for products where they make the highest commission.

If you are an investor and hold such a view then realize that THIS VIEW IS CAUSING YOU SERIOUS HARM. Let me explain how:

It is true that investment advisors and distributors often work for commission. But it is also true that the commission(s) which they make do not cause any financial harm to you. The commission they make comes out of the total fund management/ expense fee which you pay to the fund house.

Hypothetical Example

The annual Management Fee and Expense charges for ‘Crazy Man’s Discovery Fund’ (CMDF) is 1.8%* of the fund size. If you invest directly with CMDF, you pay 1.8% on an annual basis. If you invest through an investment advisor/ distributor, you still pay CMDF- 1.8% on an annual basis. In this case however, CMDF will share some portion of this 1.8% with the investment advisor who referred them the client. This could be any ratio which CMDF and the investment advisor agree upon.

Remember: By not using an investment advisor, you are effectively giving away a service which is absolutely free for you. Investment Advisory commission makes zero difference to your expense cost.

* The maximum expense ratio + management fees which a mutual fund house can charge is currently set at 2.5% according to Regulation 52 of SEBI Mutual Funds Regulations. Any advisory commissions must come from within this 2.5% cap.

Why Go with a Trusted Investment Advisor?

Experience – The job of an Investment Advisor is to continuously study securities including stocks, bonds, mutual funds and other financial instruments; and to train his psychology to help you make better investment decisions. If you believe you are reasonably good at doing all of the above, you may skip this reason for working with an investment advisor.

Also Read: Psychological Traits of a Successful Stock Investor

Knowledge & Information: Investment Advisors deal with hundreds of fund managers and clients in their daily life. In a majority cases they will have a better insight about a company’s stock or a financial product.

Misselling: Distributors often try to push products where they make a higher rate of commission. For example – out of the 14 different mutual fund companies they may be working with; they might possibly get more inclined to selling products of companies which pay them a higher commission and not necessarily the best ones.

A good investment advisor will always sell you a product THE PRICE OF WHICH HE BELIEVES WILL APPRECIATE. The reason is simple – his commission comes from you and not from the fund house. A good investment advisor, even if he were to earn his commission from the fund house**, has incentive in growing client wealth to earn higher commission. Look at the example below, where fund1 pays higher commission than fund 2, but fund 2 is a superior fund:

 ** Note: as per SEBI Investment Advisor Regulations, 2013, Investment Advisors must earn their fees directly from their clients and not allowed to charge any commission from the fund house.

 

Example

Client Invests Rs. 1,00,000
YEAR 1 

Commission rate for fund 1 – (0.7% in year 1) = Rs. 700

Commission rate for fund 2 – (0.5% in year 1) = Rs. 500

YEAR 2 

Investment amount reduces to Rs. 80,000 in fund 1

Investment amount grows to Rs. 1,20,000 in fund 2

For 2nd year

Commission earned on fund 1- 0.7% = Rs. 560

Commission earned on fund 2- 0.5% = Rs. 600

An advisor with a long term view who aligns his interests with those of his client will actually benefit more with increase in the value of his client’s portfolio which increases his commission rates.

A Word of Caution

Ensure that the Investment Advisor you are dealing with is registered with SEBI.

About Author