Saturday, February 6, 2010

Is free financial advice costing you?

Everyone loves financial advice – if it’s free. A tip from a colleague, broker, or any other joker who knows little more than what the SENSEX is, is welcome, and actually sought after. But the minute a fee is quoted, even if the individual is a genuinely smart person with valuable advice, we roll our eyes and say, you must be crazy if you think I will PAY for financial advice.

It’s especially amazing because we will, gladly or grudgingly, write a check to a doctor, lawyer or even CA, and for the most part, listen to what they have to say. When we are so kind to our medical, legal and tax advisors, what about a little charity for our financial advisors?

The blame is not entirely on the investor, because while it is pretty clear what your doctor or lawyer is supposed to do, most of us aren’t even sure what a financial advisor is or does. I’ll start by saying a financial advisor is NOT a broker. A broker’s job is purely transactional – execute the trades you want to do. A financial advisor is also NOT an agent. An insurance or mutual fund agent’s job is to sell you a financial product and help you with the paperwork required to purchase the product. It’s a different matter that many so-called financial advisors are mutual fund agents in disguise. Finally, a financial advisor is NOT a mutual fund manager. A fund manager’s job is to manage a specified portfolio of assets given to them, not to give individuals financial advice.

So, what is this eponymous advisor? For starters, a financial advisor is someone who has your interests in mind – not that of a particular AMC, broker, or insurance company. He or she is someone who will take the time to sit down with you and understand your goals and tailor a unique investment portfolio for your needs.This is more than buying equity funds and holding fixed deposits, but understanding the entire range of investment classes available to you and knowing specific products within each asset class. Gold funds, commodities, PPFs, post-office schemes, art investments, real estate, private equity – this is the tip of the iceberg of a good advisor’s knowledge. Financial products, like the human body and the Indian legal system, are complex and financial advisors should be professionally qualified – you don’t go to a doctor without a MBBS right? Finally, a good financial advisor will be your financial companion and that means having more than one meeting with you. A financial advisor’s relationship with you should be open, honest, and ongoing – one that evolves with your changing financial situation.

Now, the critical question – even if I find this wonderful advisor, why should I pay him, because I get plenty of free advice. Free advice is the bane of financial services and has cost many investors more than they budgeted.While very few people think they can be doctors, everyone thinks they are a closet fund manager or financial planner and everyone is happy to dole out free advice. The problem with free advice is that it has no quality, guarantee or liability. When a website gives you a free tip, you cannot blame them if anything goes wrong.

However, when you have paid for financial advice, you will definitely come back and blame the financial advisor – his business and reputation are both at stake. Free financial advice from professionals – brokers and wealth managers – is even more dangerous. Brokers give you free advice so that you will trade, and indirectly fill their pockets with brokerage. After all, who can ignore a well-sold tip? Wealth managers, who are supposed to look out for your interests, will charge you nothing for advice, but get compensated when you buy a product.Different products lure wealth managers with different commissions twisting their incentives from giving you the best advice to earning the highest commission. And at some level, wealth managers are not entirely at fault – they have to earn revenue, and because our mindset is so opposed to paying for advice itself, they have little choice but to make the advice free and benefit from the product sales instead.

Paying for financial advice feels painful but it is an inevitable part of India becoming a more transparent and conflict of interest free wealth management market. So, the time a smart capable financial advisor comes to you and wins over your trust, don’t balk when the word FEE comes up. A capable advisor can earn you multiples of the few percent he charges.

In the long run, free advice may cost you more than you think, and paid advice may quickly pay for itself – a quirky case where FEES are better than FREE.