Do You Know The Cost Of Mutual Funds Advice?

As an investor most of us are inclined at receiving free advice on mutual funds investments. It has been offered for a long time and even today many investments are brought at your doorsteps luring you to this free advice. But have you ever thought why in this world will someone give you investment advice free? If the professional  managing your investments is not charging a fee then how he/she is living?  Unless you have answer to these questions you will always perceive offered free advice really a free advice. 

Let’s put first thing in perspective that there are no free lunches. It simply means that  no advice comes to you free. When it looks to you free the cost is getting compensated from somewhere which you may or may not be aware of. At times we are least bothered till we have to cut a cheque from our own.

We all know about how insurance agents are compensated heavily for the products they sell. The case is no different in mutual funds which is the most sought after investment for meeting your life goals. Intermediaries/Agents/Distributors, call by any name, who sell mutual funds products have the largest presence. While they do most of the work for you there is no cost associated, as offered. This offer of completely free services was highly prevalent till entry load of 2-2.5 % was in existence. But ever since it got abolished charging fees for managing mutual funds investments gained importance.

But What’s The Cost?

Yes, that’ would be the question I would be asking to you? Do you know what cost you are paying for the mutual funds advice you are availing. Is there any cost which is getting deducted from your investments even after paying from your pocket? What’s that cost? All such questions are necessary to identify the total cost of investment advice being delivered to you especially when you engage any advisor for  a long term. Your awareness only can lead to low cost investments.

Let me explain the cost you pay in mutual funds advice. Intermediaries here are compensated  in 2 ways- Upfront commissions and then the trail commission which is yearly commission. The high upfront commission was present till regulator SEBI abolished the entry loads. It ran up to 4-6% of your total investments. But even now it is still present at some investments which are the earning any mutual fund advisor will make as soon as you invest your money. The other and a long-term recurring cost is the yearly commission which is given based on the time intermediary holds investments with the company. In the distribution language it is known as trail commissions. This commission varies for equity and debt products wherein it goes up to 1% or more in equity mutual funds. The method of deduction may not be easy for you to understand but put simply the 1% is what you are paying on your mutual funds investment to your mutual fund agent. The below table gives you a snapshot of what get paid as commissions in  mutual funds investments at different asset size –

Yearly Investment	Yearly Commissions (1%)	Total Cost for 5 Years
1000000	10000	50000
2000000	20000	100000
3000000	30000	150000
4000000	40000	200000
5000000	50000	250000
*All figures in Rs.

The chart show earnings for five years but these earnings will keep on increasing till the investments are there with the intermediary. As the asset size grows the earnings of the intermediary will also grow.

So Where is the Issue?

The intermediary gets these commission which is paid from your investments and that’s the service you perceive as free. There are two major issues which arises at this instance.

1. The first and foremost is that investors hardly know the commissions earned by their mutual fund agent. Agents rarely act under any fiduciary standard nor even they are bound by any regulations to disclose these commissions, so the onus of knowing it shift to the investors. Keeping this in perspective the regulator does have forced mutual funds companies to disclose commissions distributed to their agent in public domain but the onus should shift to agents.
2. The second issue is a much larger impact on the advice you seek and that’s when you are charged over and above these commissions. So if  your mutual funds advisor charges you, say  1%, on your total investments as the fee for managing them and also earn through commissions by investing these through him/her only then you, as an investor, actually end up paying 2% to your advisor for the advice being delivered . How many investors really know about this?  See the table below which brings you the two-sided cost for this kind of advice-

Yearly Investment	Yearly Commissions (1%)	Yearly Fee For Managing Investments (1%)	Total Cost Of Advice	Total Cost for 5 Years
	A	B	C=A+B	C*5
1000000	10000	10000	20000	100000
2000000	20000	20000	40000	200000
3000000	30000	30000	60000	300000
4000000	40000	40000	80000	400000
5000000	50000	50000	100000	500000
*All figures in Rs.

The chart show earnings for five years but these earnings will keep on increasing till the investments are there with the intermediary. As the asset size grows the earnings of the intermediary will also grow.

The larger problem here is that most of the time you do not know what cost you are actually incurring.  When any product advisor comes to you and offer you to charge 1% of your total investments and make you invest in regular plans then you are not paying 1% but 2% as illustrated above. The fee may vary with increase or decrease in assets but there is no second thought that you are paying cost in both ways. Add on cost of any  technology advantage given to you the cost of advice will rise. In few forums I have attended, have seen the intermediaries charging fee up to 1.5% – 2%  and the total cost of managing investments surpass even 3% easily. So at first step you need to understand the compensation of any intermediary or advisor before you engage for seeking advice.

Here is a snapshot of types of compensation structures through which different professionals earn-

3 Compensation Structures

The Fiduciary Standards

It’s difficult to not get inclined to any products when commissions are involved. The variation in the commissions across companies and their schemes makes an agent work towards it. But how many intermediaries actually have come ahead and disclose to you about their commissions while offering you their services. These commissions become the real cause of conflict of interest in your advisor delivery. That’s where advisers which follow Fiduciary Standards makes a great difference to your financial decisions because you come to know about them before you start to work with them. SEBI Investment Adviser Regulations have separated the advisory from product distribution where every advisor has to follow Code of Conducts and works for their client interest. These regulations have surely made advisor follow the fiduciary standards but then very few have actually gone for it up til now. There are big debates globally on making intermediaries accountable for their act and  demand for disclosure of the earnings they are receiving from their clients is on rise. India cannot remain an exception to it.

What You Should Do?

Knowing how much you are paying for the advice is necessary for you to judge the cost of advice. But not many enforce it to get aware. Do remember that every advisor has to earn and if services are offered for free then it puts advisor survival at risk. If the advisor earns from the solutions he is giving to you then the conflict of interest will come in which you should know before you make a decision. It may not be in your best interest. So next time you get  a proposal of a free advice or charged for the services the question should be raised by you to know what is the total cost you are going to pay. If you haven’t done so cause you didn’t see the cost going then time to Think Again!!!

 Image Courtesy:freedigitalphotos.net

Disclaimer: In the entire mutual funds industry there is no specific names to intermediaries. Agents/Distributors/Financial Advisors etc.. are names prevalent and so the article has used these names interchangeably.