Financial Advisors. What Are They And Do You Really Need Them?

This is a hotly debated topic in many circles. There are very opinionated views on both sides of the debate. Very rarely do I see this debate using actual metrics or numbers.

What does a financial advisor bring to the table? 

A financial advisor’s job is to help you plan your finances. To help you achieve your goal, whether retirement planning or financial independence. He will make sure you have sufficient insurance. He will help you prioritize your spending so on and so forth. 

The financial advisor will also have the ability to research different financial instruments to help you plan. You might not be aware of nuances between equity, debt, arbitrage, balanced and myriad other funds. He can recommend the best financial instruments for your life stage. 

The financial advisor should be able to put together a long term financial and investment strategy for you. 

Another important function a financial advisor plays is to be the voice of reason. When the market goes on a rollercoaster and you feel the jitters, he should be the one calming your nerves and asking you to stay the course. 

So, an advisor is a key component of long term financial planning. 

All of the above is what you get from the advisor, what does he get ? 

Well, he gets ‘fees’. 

Most advisors you encounter in the personal investment domain would get their fees from the fund house. The fund charges an expense ratio and a part of this expense ratio is paid out to the advisors who help to distribute the fund to investors.

Sounds like a fair practice. 

But, (yeah, there is always a but) these fees are not disclosed upfront. Most investors are blissfully unaware of expense ratios and the fees they pay for investing. 

If you think about the structure for a minute, you will recognise the direct conflict of interest. The advisor is supposed to be working for the investor. But his fees come from the fund house and the expense ratio that is charged. There is an incentive for the advisor to recommend funds that have higher expense ratios. 

How does this expense ratio work? 

It is a % fee charged annually on your investment value. 

That is correct, as long as your money is invested you will continue to pay the expense ratio, a part of which will be paid to your advisor. 

Irrespective of whether your investment appreciates or not, your advisor gets paid the fees. 

So, his earnings have no direct dependence on your success.

One interesting way to check whether your financial advisor is acting in your best interest is to ask him about Index funds. 

Over the last several years in the US & Indian stock markets, no fund has consistently beaten the index year on year. 

In spite of this, most advisors will not recommend index funds to their investors. 

---

My own experience was similar. I started investing in earnest in 2018. At that time my advisor recommended a basket of funds. When I asked about index funds, his feedback was that the recommended funds would do much better. Below is a scenario of what could have been, if I had invested 100,000 in each of the recommended funds in August 2018. Compared with the Nifty 50 ETF in the last row. 

Only two funds beat the index and this is over a relatively short period of just under 3 years. 

As per my advisor, each of these funds should have performed better than the index. 

If I had invested the entire sum in the Index, the result is even more pronounced.

The most telling difference is in the expense. The recommended funds would have cost me 71K vs 700 for the index. After paying for the advice I would be left with less money than a plain vanilla index investment. 

---

This lack of accountability and connection to my success is what irks me about the default investment advisors.

So, this was the case of the traditional advisor who is paid by the Fund House. There is another type of advisor. 

SEBI Registered Investment Advisor

A Fee-only advisor. You pay an annual retainer (or equivalent) directly to the advisor.

SEBI has put a program in place for registered investment advisors, as does the SEC. They are supposed to only be paid by the investor and not earn any commission from the funds. They might charge only fees or a % of investments. However, it will be paid directly by the investor. 

You can find a list of fee-only advisors here. 

To my mind this kind of a relationship has less conflict of interest. Both are working for direct mutual benefit. 

Since the advisor deals with a person’s life savings, it must be a really tightly regulated industry! 

Well, sadly no! There is scant regulation on who can give financial advice. 

SEBI requires RIAs to have passed the NISM exam, which is about it. 

But a large section of investment advisors are mutual fund distributors and there are no significant entry criteria there. Especially when it comes to Financial Advisory companies. The company will decide its own criteria and who it will employ for financial advisory. 

This leaves the field open for dubious advisors who don’t have your best interests at heart. Since there is no real transparency and accountability on the advisors there is no way for a layperson to distinguish the genuine advisor from the charlatan. 

This is an industry that relies heavily on personal reference. 

For you, as an investor, it is very important to understand who you get your referrals and recommendations from. Are they themselves qualified to distinguish good financial advice from bad? 

So, what is the final verdict:

The financial advisor plays a very important role. He helps you focus and prioritize what is important in terms of savings for the future. He will be able to shape your planning and put things in perspective. But like all things personal, this is not an area you can give over to someone else and let go. You need to be deeply involved and question your advisor.

Ask your advisor about index funds, this is usually a litmus test to understand their alignment with your long-term interests. 

Before you sign up with an advisor, understand how they will be compensated and double-check any conflict of interest. 

It is your hard-earned money after all, who better than you to take care of its proper investment. This is not the easy way out, it requires time and effort. It also means you have no one to blame if you make wrong investment decisions. But it will steer you clear of unnecessary fees and poor advice. 

For now, I am not using a financial advisor.

Take care of your money yourself, or else someone else will. 

Let me know your personal experience with advisors, good or bad. You can also read up about how it started for me and about the very basics.