Your Financial Advisor Doesn’t Work For You

We have all heard and read about people who have lost money in this insurance scheme or that mutual fund. Why does it happen so often? Whose fault is it?

Meet the main culprit: conflict of interest. All professional codes attempt to minimize it and it creeps into everyday life anyway — the doctor prescribing a pill under the influence of a pharmaceutical giant, or the bank CEO taking inappropriate risks with depositor and shareholder money. In the area of personal financial advice in India, conflict of interest is rampant.

The basic concept of alignment of interests is a simple one. If I advise you or provide a service to you, my benefits must ideally be proportional to your gain from my advice, service, etc. And — this is key — I must be paid by you.

Nothing is further from this than the incentive structure of the garden variety agent or distributor in India, often conducting business under the garb of financial advisor. If doctors were to work like these guys, the surgeon would be paying your general practitioner to give you free advice (“Mr. Shah, that condition of yours definitely needs surgery and I happen to know just the expert to do it”).

The agent gets from the insurance or mutual fund company a percentage of the premium or investment made by the client. This is all perfectly above board — the system is set up this way. Only recently has the Securities and Exchange Board of India (SEBI) introduced regulations for a category of advisors who are truly independent from the “product manufacturer”. The regulation unequivocally states that only the client is allowed to compensate the advisor. It is yet to be seen if this will change anything, although early reports have suggested that there are few takers (SEBI’s regulation allows exemptions which means that it is not mandatory for an advisor who is also a commissioned distributor to register). Could it be that it’s more profitable to stay unaligned with the advisee, i.e. you?

The result of this misalignment is that the agent is biased towards not the best scheme or fund for your money but the one that pays him the highest commission. The clever hoodwink in the system is that because you make the cheque out to a well-known brand name, not the agent, you are kept under the illusion that your interests are being looked after. Were you referred to the right surgeon? Was the surgery required in the first place?

There’s an old German proverb that goes like this: Whose bread I eat, his song I sing. That financial advisor of yours is not eating your bread but he could very well be eating your lunch.

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Image © Nathan Y

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