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Why commission based Mutual Fund Distributors (Agents) are unable to give proper financial advice?
That’s a strong statement to make. Right?
But this is a fact.
Let me try to explain why I am saying this.
But first, I hope you know the difference between Regular Plans and Direct Plans of Mutual Funds. If you don’t, I strongly suggest you read the article differentiating between them first.
Now, Mutual Fund distributors are basically product sellers. They sell products (Regular Plans of Mutual Fund schemes) which earns them commissions.
So if they are product sellers, is it that they may not advise you properly?
Yes, it’s possible.
Because there is a clear conflict of interest. And MF distributors only earn via commission from the sale of regular plans of mutual funds. There is nothing wrong with selling regular plans. But stay with me and you will realize where the problem arises.
Suppose, that a Mutual Fund Distributor decides to sell only 5 schemes which give him following commissions every year:
- Mutual Fund A – 0.50%
- Mutual Fund B – 0.75%
- Mutual Fund C – 1.00%
- Mutual Fund D – 1.20%
- Mutual Fund E – 1.50%
As an informed investor, you know that all mutual funds are not the same. And that different mutual funds are suitable for different goals. So after some analysis, you found that for your goals, Mutual Fund A and B will be the best ones.
If you invest in schemes A and B, how much commission the distributor will get?
He will get 0.50% and 0.75% on your investments.
Now, look at it from the perspective of Mutual Fund Distributor, who is a businessman and wants to earn more. He knows that schemes D and E give him more commission (1.25% and 1.50%). So naturally, he would want to sell you those schemes.
Isn’t it? He will want to maximize his earnings by selling you higher-commission schemes.
But whether schemes D or E are suitable for you?
The answer is No as you already know (assumed earlier) that A and B are better suited.
And that is the problem.
The advice or recommendations that these regular-plan selling mutual fund distributors give is biased. Biased because they want to earn high commissions. And at times, this earnings-maximization conflicts with what the right investment advice is.
So even when the right funds for you are A and B, chances are very high that the MF distributor will push you to go for schemes C, D and E. He will not tell you why exactly (which is due to high commissions) and instead, try to convince you using redundant and useless arguments.
Whether the schemes the MF distributors sell are suitable for you or not is something that they may not be worried too much about. They will convince you to buy whatever they are selling; and which without doubt is what offers them highest commissions.
Is this right? Is this wrong?
You are smart enough to know that.
But I don’t want to paint all mutual fund distributors (or sellers) with the same brush of being biased and commission-oriented. Some are good guys and do have the skills and intent to ensure that their clients do well. But you need to understand their limitations. After all, they need to earn money.
One more thing. Mutual fund distributors are paid commission which is a percentage of your investments. The commission varies from one fund house to other. Some fund houses may offer higher commissions to incentivize the distributors to push their products more. So without mincing words here, it is obvious that quite often, the investment advice and exact recommendations will be influenced by the commission the mutual fund distributor is getting. Think about it.
Many people feel that these distributors don’t charge anything directly and hence, their financial advice is free. But it isn’t. You are paying for it via commissions and that reduces returns of regular plans that these distributors get you to invest in. And this is the reason that Returns of Regular plans sold by distributor will ALWAYS be LOWER than Direct Plans.
And these distributors don’t just receive commission one time. They receive trail fees (or commission) for as long as the investor stays invested. So the longer you stay invested, the more commission income the distributor receives. Let’s say you invest Rs 1 lac in the first year. And the distributor gets 1% for that. The next year too, he will get 1% commission for that same Rs 1 lac again! And also the next year. And if you invest more, then he gets more commission on the fresh money.
And all this on-going commission is paid from your investments which reflects in the difference of the NAVs of Regular and Direct Plans.
You may feel that 1-2% is a very small amount to bother about. But since the commissions for these MF sellers is linked to the size of your portfolio, the commission can become substantial once your portfolio grows larger. And you can save that 1% or more of commission by investing in direct plans of mutual funds.
The commission paid to these distributors and IFAs are paid from your investments (which results in lower NAV and returns of Regular Plans). So less you pay them as commissions, the more you keep for yourself. Plain and simple. Read this article to understand how and why?
Let me share an analogy if you still have doubts.
Whom would you take medical advice from? A person who just sells medicine or from a Doctor?
The answer is obvious – You go to a Doctor!
Because first, the doctor is licensed to give the right advice and knows which diseases require which medicines. On the other hand, the medicine seller (who to be fair also knows a thing or two about diseases and medicines) will try to sell you medicines which apart from curing the diseases will also give him highest margin (earnings).
And that is the biggest problem with these product sellers.
They will try to convince you and force-fit all your requirements with the products that they sell. And that is not right. It’s possible that the products or schemes which they are ‘not’ selling may be better suited to you. And they won’t tell you that because they will lose potential commission income then.
And since they earn only from what they sell, it’s not necessary that the product they are selling is the right one for you. The advice they give may seem free, but it may be the wrong advice! And when it comes to finances, free advice can be very very costly.
Think about it (and I quote a view from here) – Recommending suitable or appropriate products requires the adviser know the client…. Yes, I believe distributors can do this job and need to do it better than they do today. A good adviser might help a client understand if she should even buy an investment or should she pay down debt instead? Should they delay their retirement or save more of their income today? Someone who is compensated to sell products (i.e. distributors) has no motivation to have clients pay down debt, whereas a good adviser looking after the client’s best interest should look at many factors in advising the client. I believe clients are better served by a good adviser (SEBI RIA) than they are by a product salesperson (i.e. MF distributors)…
Realizing the importance of providing investors access to quality and conflict-free investment advice, SEBI had brought in its Investment Adviser Regulations in 2013.
Who are SEBI Registered Investment Advisors (SEBI RIA)?
The Registered Investment Advisors (RIA) are licensed by SEBI to give proper, conflict-free investment advice to their clients. They are not product sellers (or distribute products) and they do not earn from commissions. Instead, they only earn from the fee paid directly by clients. Since no sale of commission-generating products is involved, the inherent conflict of interest is avoided.
This importantly means that the suggestions or advice coming from RIAs will be what is best suited for you and your goals. No wrong advice due to commission-based earning in case of SEBI registered RIAs.
Since RIA (Investment Advisors) are not product sellers, their focus is not in pushing the sale of any particular product. Their focus is the investor and their real financial goals.
It is only after knowing about clients needs, goals, assets, investment capability, risk appetite and risk capacity, etc. that the Fee-Only Financial Planner or RIA will do a detailed analysis, evaluate multiple scenarios and only, then create a proper, well-thought-out financial plan.
It’s obvious that a plain product seller (like mutual fund distributors) will not be deep diving so much to try and understand your financial life. He will simply try to sell a product (that gives him solid commission) rather than understand your financial needs.
Mutual fund distributors don’t take a fee from you but they get a good commission from mutual fund houses. So the investment recommendations can be influenced by the commission the distributor is getting.
In my view, if you wish to take proper and unbiased financial advice, you should contact SEBI registered Investment Advisor. I am one myself. But there are many others. If you wish to get in touch with, please use this form. Or if you wish to find an investment advisor near you, then you can also have a look at a list of registered Investment Advisors on SEBI’s site (it is an alphabetical list and I am also there in ‘D’ – you scroll down a bit and you will find Dev Ashish, SEBI Registered Investment Advisor).
So I hope you now know how mutual fund distributors (agents) may not serve your interest properly due to the commissions they get.