IMP-OST : 3rd Sep, 2012 ( Post 3 of 7 )
Special edition - Financial planning
Source : i-Secure Solutions' website
There are many types of financial planners.
They can be broadly divided into three categories.
Fee-only planner
Fee only planners provide advice to their clients for a set fee.
They are not reimbursed by companies whose products they recommend as they would not be holding agency of manufactures of respective products. There are no commissions.
The big advantage of using a fee-only planner is that you receive un-biased financial advice.
The fee-only model of compensation reduces the potential for conflicts of interest between the advisor and the client in that the advisor is not beholden to insurance companies, particular investments, and other financial companies.
A fee only advisor may reduce conflicts of interest* such as:
An incentive to generate commissions through the unnecessary buying/or selling of stocks, insurance products, other products ( also know as churning ).
An incentive to convert non-cash assets such as real estate and collectibles to cash and securities so that the advisor can generate a commission.
Commission-only planner
This type of planner provides financial advice, but also tries to sell products to their clients that generate commissions.
Type of products includes mutual funds, term or while life insurance, ULIP, Pension plans, and other investments.
The big disadvantage of commission-based planner is the conflict-of-interest* that results from their recommendations - for products that generate handsome commission for them, not you.
Commission-only planners usually work for insurance companies, brokerage houses, or banks.
Except for the financial advice they offer, they are not that much different from a regular salesperson.
Fee and commission planner
These planners earn from both the client as well as the investment companies in the form of fees and commission respectively.
On the fee side they charge certain amount of fee from the client for the services like creating a financial plan or engage in more limited planning activities, such as helping you to pick mutual funds or set up and automatic investment account for a childs college tuition.
On the commission side, they get commissions for products which they sell to their clients from the companies / institutions.
These type of planners are ideally suited for small investors who can not afford high fees.
Why should I pay extra fees from my pocket?
Fee-only planner
Fee only planners provide advice to their clients for a set fee.
They are not reimbursed by companies whose products they recommend as they would not be holding agency of manufactures of respective products. There are no commissions.
The big advantage of using a fee-only planner is that you receive un-biased financial advice.
The fee-only model of compensation reduces the potential for conflicts of interest between the advisor and the client in that the advisor is not beholden to insurance companies, particular investments, and other financial companies.
A fee only advisor may reduce conflicts of interest* such as:
An incentive to generate commissions through the unnecessary buying/or selling of stocks, insurance products, other products ( also know as churning ).
An incentive to convert non-cash assets such as real estate and collectibles to cash and securities so that the advisor can generate a commission.
Commission-only planner
This type of planner provides financial advice, but also tries to sell products to their clients that generate commissions.
Type of products includes mutual funds, term or while life insurance, ULIP, Pension plans, and other investments.
The big disadvantage of commission-based planner is the conflict-of-interest* that results from their recommendations - for products that generate handsome commission for them, not you.
Commission-only planners usually work for insurance companies, brokerage houses, or banks.
Except for the financial advice they offer, they are not that much different from a regular salesperson.
Fee and commission planner
These planners earn from both the client as well as the investment companies in the form of fees and commission respectively.
On the fee side they charge certain amount of fee from the client for the services like creating a financial plan or engage in more limited planning activities, such as helping you to pick mutual funds or set up and automatic investment account for a childs college tuition.
On the commission side, they get commissions for products which they sell to their clients from the companies / institutions.
These type of planners are ideally suited for small investors who can not afford high fees.
Why should I pay extra fees from my pocket?
There are two ways through which your financial advisor earns.
Commission : Your advisor gets a commission on the product you buy from the company selling the product.
Fees : You pay separate fees to your advisor for the advice, help in executing transaction, service etc.
What is better, commission of fees ?
Well actually it is you who are paying the advisor in both the cases !
Product commissions that gets paid to your advisor eventually gets deducted as expense from the amount you invest.
For example, if you invest Rs.1,00,000/year in financial product, the product company may deduct (3%) Rs.3,000 as distribution expense and pay it to your advisor as a commission for selling the product. So, in effect only Rs.97,000 actually goes to towards the product as your investment.
While the abolishment of entry loads have brought transparency in mutual funds, other financial products continue to have high distribution expenses. The commission in other financial product vary from 1% to as high as 40%. Hence there is still a strong possibility of advisor recommending you a product which may give him high commission even though it may not be suitable to your needs.
Taking above example by considering just 20% commission, if you invest Rs.1,00,000/year in financial product, the product company deduct Rs.20,000 as distribution expense and pay it to your advisor as a commission for selling the product. So, in effect only Rs.80,000 actually goes towards the product as your investment !
Paying fees is more transparent.
You have the right to ask your advisor to disclose the commission amount he/she is earning from the product manufacturer.
You should encourage transparency. Transparency in compensation is the best way to judge the trustworthiness.
*Conflict of interest can arise when...
When an Insurance agent (associated with Insurance company) try to sell any insurance plan/s.
When an Insurance agent (associated with Insurance company) try to sell newly launched insurance plan.
When an Employee of Insurance company try to sell insurance plan/s.
When an Bank employee try to sell Insurance plan (may introduce just as good product), Mutual fund / SIP during your visit of branch.
When Mutual fund distributor try to sell newly launched mutual fund (NFO).
When an Insurance agent suggest you to surrender particular policy to buy new policy.
When stock broker suggest you to trade more!
Always remember that...
- Insurance agent earns from the product they sale, not by protecting your interest. They have to work under assigned target as well as self set sales targets to earn commission. On achieving set targets they also earn gifts & trips !
- Mutual fund distributors get commission on sale and on your portfolio retention - from associated asset management company. SEBI had banned front end loading charges, and guided distributors to collect fees from customer - which is right direction.
- Stock broker can earn more by recommending you to trade more by giving sure shot tips ! It does not make much difference to them whether you make profit or loss !
- Employee of Insurance company / sales force of bank, work under assigned targets, they get promotions on achieving sales target; not protecting your interest ! Chance of leaving company for better prospect, or due to poor performance ( not achieving sales target ) will be always there ! They know after few years, due to promotion or company policy transfer will be always there. So just think where your interest protection stand in their life?
- Person sitting on call centre, can earn more on generating positive leads which get converted in to sales.
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