Choosing the right financial planner is a wise investment, say experts

Discussing scope of work will enable the registered investment advisor to decide the right fee

Today (October 6) is World Financial Planning Day. If you have not got a financial planner yet, but feel having one will help you achieve your life's key financial goals, today is the right day to kick your plan into action.

Go with a Sebi RIA

The person offering financial planning should be registered with the Securities and Exchange Board of India (Sebi) as a registered investment advisor (RIA).

“This is the first qualification you should look for,” says M Pattabiraman, founder, Freefincal.com.

Sebi's website has a list of all RIAs in the country.

When you meet the RIA, explain the scope of work you expect. Younger investors often want just one-time help with a basic plan. Those with higher networth require continuous hand-holding.

“Discussing the scope of work will enable the RIA to decide the right fee,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-registered investment advisor.

A written agreement must be signed between the RIA and the client.

“It should not contain any clause that hands over discretionary powers to the advisor,” says Rajesh Krishnamoorthy, country head, financial planning standards board, India Liaison Office.

Get one clause inserted into the standard agreement.

“It should state that the advisor cannot earn a fee on any product suggested by him,” says Avinash Luthria, a Sebi-registered investment advisor and founder, Fiduciaries. 

This will help plug any regulatory loophole.

“Sebi's rules only mandate that the advisor shouldn’t earn a commission from Sebi-regulated products. An unscrupulous RIA could try to earn commissions on products under other regulators,” adds Luthria.

Get clarity on fee

Sebi allows RIAs to charge a fee based on one of the two models: fixed fee or percentage of assets under advice (AUA). It has stipulated certain limits on both. An RIA can’t charge more than Rs 1.25 lakh a year under the former, or more than 2.5 per cent under the latter.

Get clarity on the fee you will pay from the second year. The effort required from the RIA reduces.

“A recurring fee that is 50 per cent of the initial fee is fair,” says Pattabiraman.

Fixed fee: Race to the bottom

The fixed fee is stated in Indian currency, so the client knows how much he has to pay annually. When stated as a percentage of AUA, some investors may not realise how much they will end up paying over the long term.

However, this structure often shifts the focus entirely to the fee. Clients gravitate towards RIAs who charge less. RIAs then begin to compete on fee. They do so by devoting fewer hours to each client, offering standardised portfolios, and not dealing with specific problems of clients.

This shortcoming can be overcome if clients agree to pay more for extra service rendered.

Percentage of AUA: Scope for conflict

Here, the RIA is able to charge more from clients with larger portfolios, which usually require more work. However, consider a few nuances. One is the exact percentage charged. If it is 0.25 per cent, it is a good deal. But if it is 0.75-1 per cent, the usual range, that could be a considerable sum over a lifetime.

“Ensure there is a connection between the quantum of effort put in by the RIA and the fee,” says Luthria.

Conflicts of interest can arise. Suppose a client wants to pull money out of his mutual fund investments to prepay a home loan. Will a financial planner on this model, knowing his fee will plummet, advise him to do so?

This model carries another big risk.

“The RIA wouldn't want to lose a high networth client paying 0.75-1 per cent of AUA each year, so he may suggest complex products. Since the client wouldn't understand them, he will continue to pay the high fee and stick to the RIA. Whether such products add value to the client is questionable at best,” adds Luthria.

HAVE THE RIGHT RISK-RETURN EXPECTATIONS

• Beware of an advisor who promises high, market-beating returns

• Such an advisor could expose you to more risk than you can stomach

• Discuss with the RIA what a plausible rate of return is

• Quiz the RIA about steps he will take to mitigate risk

• Go with a person with whom you are comfortable discussing both your aspirations and vulnerabilities

• Do at least a Google search to avoid going with someone against whom there has been regulatory action