Is Your Financial Advisor Conflicted?

It’s an unsavoury truth that mis-selling of Financial Products, resulting from conflicted advice, has cost hapless Indian investors crores of their hard-earned savings over the decades. For instance, an IGIDR paper recently estimated that Indian investors incurred a staggering loss of about Rs 1.5 trillion (1.5 lakh crore) owing to mis-selling of Life Insurance products alone, between 2004 and 2012. Similarly, A 2012 Harvard Business School study on the Indian Life Insurance provided conclusive evidence that “life insurance agents appear to focus on maximizing the amount of premiums (and therefore commissions) that customers pay”. And truth be told - although Life Insurance has ignominiously evolved as the poster child for mis-selling over the years, the fact remains that sharp selling practices exist in almost every sub domain of the financial advisory profession – stock broking, lending, real estate advisory and even mutual funds.

In such a scenario, what can the average investor do to safeguard himself from succumbing to dubious sales tactics employed by many so-called advisors? Is there a litmus test for conflict-free advice? Although there’s no magic formula for assessing this, there are, fortunately, a few aspects of your advisor’s modus operandi that can help you gauge whether his advice is unbiased or not.

Insurance Centric Model
If your Advisor recommends an insurance product as a silver-bullet solution for all your financial problems, you may have reason to worry. Life Insurance is, by far, the highest commission earning product for an intermediary. On average, traditional policies (the lowest yielding ones) fetch your Advisor somewhere between 30% and 50% of your first-year premium as a reward for selling the product, plus a trail income on your subsequent annual premiums.

Compare this with the 1.5% to 2% that your Advisor would earn on higher growth potential products such as Mutual Funds (and even lower on low cost products such as NPS), and it suddenly becomes clear why an insurance policy is the first to emerge from most advisors’ bags of tricks. While Insurance (both Life and Health) are very critical aspects of a Financial Plan, watch out for an Advisor who aims to position it as a solution for all your financial goals, without considering and presenting other options. Also, a non-conflicted Advisor will take care to ensure that the policy you are purchasing is solving the main purpose of insurance (a high death benefit and protection against damaging, unforeseen medical expenses) while keeping the annual premiums low.

Excessive Churn
Good investments are, by and large, meant to be passive. If your advisor is focused on moving you in and out of investments too frequently, you need to be careful. There’s a clear possibility that he is migrating you from lower income yielding products to higher income yielding products whenever the opportunity presents itself, usually to your detriment. This phenomenon was disturbingly pronounced in the mutual fund distribution business during the early part of the millennium, when entry loads were still permitted and NFO’s (New Fund Offers) fetched exorbitant commissions. So-called Advisors had a ball, flipping clients from NFO to NFO, earning as much as 20-25% commissions (as a percentage of the corpus) in the process – at the expense of clients. Fortunately, we have a very evolved and customer-focused intermediary at the helm of affairs in the form of Sebi, and this loophole was quickly plugged.

Within the broking industry, churning or trading is the “sine qua non” of the business even today, as brokers only really earn anything when you move in and out of stocks or derivatives frequently. Resultantly, clients often lose money by adopting purposeless strategies such as leveraged, intraday trading and BTST (Buy Today, Sell Tomorrow) – whereas they could have stayed put in value stocks for the long term and raked it in (much to the chagrin of their broker-advisors, or course!)

No Clear Investment Policy
A conflict free advisor isn’t a mere ‘product peddler’ and will have a clear investment policy and process in place. More specifically, a financial planning led model can be a very clear indicator that your Advisor is acting in a fiduciary capacity, and not with the intent to maximise his revenues from your hard-won savings.

A conflict-free advisor will have in place some very clear criteria for making recommendations, starting from a robust risk profiling process that dovetails into a clear asset allocation strategy, based on your individual profile as well as his tactical market outlook. Preferably, your advisor should make no distinction between financial asset classes, dealing in both physical (real estate and gold) and financial (mutual funds, deposits bonds) assets. Your Advisor must have a crystal-clear thought process that goes into deciding which investment suits whom and why, when to rebalance and based on what criteria, what his market outlook is and why, and so on. On the other hand, if your Advisor knocks at your door every time a new product is launched (“Sirji, ek badiya product launch hua hai” sounds familiar?), you can be sure that your Advisor isn’t really an advisor at all.

Discomfort About Revenue Model
A conflict-free Financial Adviser will have no qualms disclosing his revenue model to you with 100% transparency, and with zero hesitation.

Good advisors are completely unapologetic about making money from dispensing advice; some even go as far as believing and openly stating that they are in fact, being paid less in relation to the value of the service they are providing! Conflicted advisors, on the other hand, stutter and stammer, and beat around the bush while stating how they make money, and how much. Deep down, they know that they are commission motivated, and this stops them from being straightforward about their revenue models.

Be sure to question just how your advisor makes money, and how much. If he’s making anything more than 3% of your corpus (all combined) each year, you’re clearly paying way too much – and you need to reconsider your relationship with your advisor. Even worse, if your advisor fails to provide you with a satisfactory answer to this question, run for the hills immediately and seek out a CFP or Sebi Registered Investment Advisor to oversee the growth of your hard-earned money.