Zero-fee financial services can prove to be expensive

It is tempting to use zero-fee services paid for by other, financially less literate clients. But none of us is completely immune to being conned

Diversification and minimising investment costs are the two most important rules of investing. For example, low-fee passive index funds, such as the Nifty50 index fund, are better than higher-fee active mutual funds (MFs). So, superficially it would seem that zero-fee financial services ought to be beneficial. In reality, zero-fee or absurdly-low-fee financial services can ultimately result in very high cost to investors.

This is specific to financial services since the massive benefit or damage is often in the distant future and is usually very difficult to evaluate. But this does not apply to government-mandated services such as mfcentral.com. Here are examples of five ways in which zero fee can prove to be extremely costly.

Hidden fees

Regular plans of MFs often have double the annual fees of direct plans of MFs but the additional annual fees are not explicitly disclosed. So, many clients assume they are paying the MF distributor zero fees while in reality, they are paying extremely high annual fees. Or a MF fund-of-fund may have almost zero fees, but it could invest in other funds of the same fund house that have extremely high fees.

Upselling or cross-selling

A company may offer some baskets of stocks with zero advisory fee with the aim of upselling many clients to buy other baskets of stocks where the advisory fees are excessively high. Or a company may allow clients to buy MFs without any brokerage fee and eventually cross-sell the buying of equity shares with a very high brokerage fee.

Creating dependence

A Sebi-registered investment advisor’s (RIA) fees may be absurdly low in the first year of engagement. After the RIA has made the client dependent on the RIA, by creating an extremely complicated portfolio, he may charge extremely high fees from the second year onward.

Creating an addiction

A company may charge clients zero brokerage fee while buying equity shares, in the hope of getting most clients addicted to frequently trading shares. This addiction then leads clients to need an even bigger thrill, such as futures and options trading, where the gains and losses are magnified. And the company can charge such addicted clients extremely high brokerage fees for futures and options trading, which is likely to be catastrophic for most clients.

The too-clever-by-half response

Many people believe they can use the free services and be careful not to use the very expensive services from the same company. This is unlikely to happen in practice. A client may avoid one expensive service (e.g., Portfolio Management Services) and later fall for some other even more complex and expensive service (e.g., Long-Short Alternative Investment Funds). Or a client may avoid expensive services when he is in his 50s but fall for them when he is mentally less sharp in his 60s. Or the client may avoid expensive services, but after he passes away his family may fall for those services.  

It is tempting to use zero-fee services that are paid for by other clients who are financially less literate. But none of us is completely immune to being conned. So, instead, try to select financial services that have transparent fees that are neither too high nor too low. It will also force you to ask yourself whether you really need that service. And this may also reduce the risk of toxic services such as futures and options trading being sold to you.

The writer is an hourly-fee financial planner and a Sebi RIA at Fiduciaries.in. He was a private-equity investor for 12 years