As an Indian investor, you come across financial advisors in many forms. From your LIC agent to bank RMs to Mutual fund distributors to loan agents to Registered Investment advisors. An RIA is a new type of financial advisor that SEBI officially calls an Advisor.
In Financial Services, you have traditionally paid for advice indirectly through product commissions, brokerage, etc. The advice rendered is incidental and is not paid for. It is no wonder advice tends to serve the advisor’s motives rather than yours. Financial intermediaries tailor advice to shepherd customers into buying products.
Under the modern definition of financial advisors, the older commission-based advisors are now considered financial intermediaries or product distributors. An intermediary wants to sell the product s/he is dealing with, and among them the one that offers the best remuneration. As a result, intermediaries may sell products that do not align with the customer’s needs. Remuneration plays a major role in customer outcomes, and even well-meaning regulations have not changed that.
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Paying for financial advice
To address this imbalance, SEBI introduced a class of fee-only advisors through the RIA Regulation. The regulation came into force in 2013, just after you started getting direct options for all available mutual fund schemes. They are legally bound by a Fiduciary Standard of care, which requires them to put their clients’ best interests ahead of their own.
Unlike product distributors, who are bound by a lower Suitability standard, which allows them to sell products that are broadly suited to the client’s situation and receive remuneration in the form of brokerage and commissions, fee-only advisors are paid by you. It’s similar to how you pay fees to doctors.
SEBI regulations also address how you will pay for financial advice. You may find two options: a fixed-fee option and an AUA-based fee option. Under the fixed-fee option, the advisor charges a fixed fee each year or month, whereas under the AUA-based option, you pay based on the value of the assets the advisor manages.
However, advisors disclose conflicts of interest to clients upfront, even though that does not eliminate the conflict. In the fixed-fee model, the advisor charges a lump sum for an estimated amount of work, which is not connected to the quantum of assets. The problems start there.
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Fixed fee vs. fee charge: Which one is better?
In reality, different services can be offered under a fixed-fee model. From the top, everything looks similar, but in reality, your financial needs can’t be the same as another’s. Under a fixed-fee model, it becomes challenging for the advisor. To deliver a solution that varies from client to client, the advisor needs to estimate and charge the fee correctly for each client and service.
The fixed-fee model might look simple and affordable to you, but the AUA model seems ideal because
First, the fixed-fee model is limited to Rs. 1.25 Lakhs pa. This poses problems if the client is a wealthy investor, for whom the advisor must consider a diverse range of products and may need sophisticated & nuanced advice across multiple areas. If they cannot charge more than the limit set by Regulations, the advice & services will not be of the requisite quality or depth. This fee limit can be a serious problem.
Second, in a fixed-fee model, the advisor has no incentive to help grow assets, unlike an advisor who charges you on Assets Under Management (AUM) or a fee-charge model.
An advisor charging on an AUM basis grows wealth in both parties’ interests. Hence, with aligned interests, they work in harmony and deliver better outcomes.
In specialised services, one charges for expertise, not just time or the underlying product. This happens in all fields.
For instance, an experienced and sought-after lawyer may charge several lakhs for a court appearance, while another may charge just a few thousand rupees. Expertise, experience, and reputation take time to build. Monetisation will be possible only in the later stages of the career. A fixed-fee model with a limit of Rs.1.25 Lakhs pa would be a huge hindrance to that.
Third, in a fixed-fee model, you receive discrete services as you go. The prices for each service will differ and will need to be discussed and agreed upon through several rounds of back-and-forth. This is cumbersome & takes time. The fixed-fee model is great for transactional relationships (like a doctor consultation).
In an Asset Under Advice model, the relationship is typically ongoing. Most services are offered to the client as part of the engagement, and you charge a percentage of assets. This makes it easy to charge a single fee for all services, calculated as a percentage of assets. This is simple to understand and easy to implement.
Fourth, an advisor takes responsibility for achieving goals and desired outcomes in life on time. Also, advisors help clients accumulate wealth, build it over time, and achieve their potential. That is an invaluable service and a huge responsibility that the advisors shoulder. Clients are engaged with advisors for decades. The advisor needs to be remunerated for the responsibility s/he shoulders.
A related example is a CEO who runs a company and is responsible for achieving the company’s objectives and profit targets. S/he gets paid a lot more than most others in the firm for shouldering this responsibility and not for putting in extra hours in a day.
Similarly, advisors should be paid for the responsibility they take on for their clients. The easiest way is to align with their clients’ wealth and charge a percentage of it, which the advisors helped create.
Many people wrongly believe a fixed fee is cheaper and an Assets Under Advice (AUA) fee is costlier. In reality, they are quite close. This is because clients know what services cost with other advisors in rupee terms, regardless of the model.
Also, advisors know market rates, regardless of the model. Advisors in either model would not engage with the client if the remuneration is not sufficient. Hence, the fees charged in either model would converge in any case.
Currently, under IA Regulations, an AUA fee of 2.5% p.a. can be charged. However, the AUA fees charged in reality are far, far less. That, again, is based on market dictates.
A fixed fee may work in some instances for some clients, and the same holds true for AUA fees. Taking sides in the charge model is hence unnecessary hair-splitting and unproductive.
Your Financial Advisor should focus on ensuring great outcomes for clients.
NS Wealth Solutions Pvt Ltd is a Fee-only financial Advisor in india and provides financial advisory services all over India : Agra | Ahmedabad | Balasore | Bangalore | Bhopal | Bhubaneswar | Chandigarh | Chhatrapati Sambhaji Nagar | Chennai | Coimbatore | Dehradun | Delhi | Ghaziabad | Greater Noida | Gurugram | Guwahati | Hyderabad | Indore | Jaipur | Jamshedpur | Kanpur | Kolhapur | Kolkata | Lucknow | Ludhiana | Mumbai | Nagpur | Nashik | Navi Mumbai | Noida | Patna | Pimpri Chinchwad | Pune | Rajkot | Ranchi | Sangli| Surat | Thane | Udaipur | Vadodara | Varanasi
