This article of economic times Can You Trust Banks put forth a very pertinent debate over Fee vs Commissions. Indulged in mis-selling of financial products the situation is derived from the fact that there are high incentives involved in selling a financial product. These lucrative incentives are high enough to meet the 3 times income targets as rolled out in many Financial Institutions but known only to the seller. The recent spat of changes in the investment advisory space is a result of presence of this compensation structure. Now with SEBI Investment Advisers Regulations in place and a gradual acceptance of fee compensation the debate over fee vs commission is gaining ground.
There has been strong arguments raised for commission compensation especially when it comes to serving the mass middle-class investors. A more prominent one is that in absence of this compensation the investment advice to large section of society will become unavailable. But we have seen that globally low-cost compensation models are evolving and giving birth to financial planners starting to serve the large middle class. It will be tough to believe that India will be left behind especially after SEBI Investment Advisers Regulations coming in.
To understand more about why fee compensation is more preferable we need to understand the disadvantages the commission compensation brings to the investors table:
Commissions Are Hidden
Commissions in any form are hidden costs for consumers. When I say hidden cost it means the consumer does not comes to know about and is hardly made known from the product seller. Commissions are an incentive to sell any financial products where understanding the consumer needs is largely absent or ignored. Insurance have been the bigger proof of this fact wherein agents have pocketed high commissions by selling products which have not benefited consumers at large. The cash value products or the traditional insurance products and then the ULIPs all have been sold mainly for commissions. The cases are no different in mutual funds where the presence of high upfront commissions was the biggest attraction of selling them. The commissions might have reduced in some manner but the presence of compensation remaining hidden from the investor puts the advisor interest on the top. Moreover the difference in commissions from different companies makes the incentive of selling more lucrative. But all this remains hidden from the consumer and advisors do not practice disclosing this compensation to their clients. The fee compensation removes this disadvantage where the advisor works with the client only when the agreement is there on the fee payable .
Wrong Value Perception
The trend of earning commissions has been to makes services free to consumers. Practiced in the longer term it has built a perception that the investment advice for any level comes free. The consumer never ever comes to know what is the value of any investments advice as there is no limit to the services being availed. This is true especially among the large segment of middle class where the free advice has become a trend. The advisor earning from commissions offers to do most of the work without involving any fee. But we have seen what the consumer pays in this compensation is way above the level of advice which he/she receives. Contrary to this when the advice is received by paying a fee then there is a keen interest to know the scope of service involved. A relationship built along this line has more scope of understanding the values one derives for the level of services being offered.
No Long Term Relationships
When commissions are high and upfront then inclination to build long-term relationships is very rare. Be it insurance or mutual funds’ investments the upfront commissions have ensured the focus shifts to maximizing the earnings for advisor then to see whether the investor reaching the goals or not. Many advisors vanish after getting in the first few years of revenue and many do not bother to call again. Contrary to this when the client-advisor relationship is built on a fee which is known to both the parties then both have an interest to maintain the long term relationship. The ongoing relationship built through the fee compensation put more thrust on advisor to see what client is achieving in his/her lifetime.
Missing Service Quality
With commissions, there has always been a quality gap in solutions offered to the client. The advisory has been restricted to what the product demands and not what the consumer need. Holistic Financial Planning is hardly practiced when there are compensations involved. Also, for advisors relying on commission compensation if the needs of a consumer demand a product which should not involve any commission then it is unviable for their advisory. That’s what is happening with direct plans in mutual funds which is a no-commission product and only handful of advisors working on fee compensation recommending it. It will be missing from the financial advisors recommendation list since it does not earn any commission. Thus, commissions do always have a push for a product which will lowers the quality of service being offered. The emergence of holistic financial planning on fee basis has made the good quality of service available to even the smaller investors who otherwise are being left out for the commission compensation and they never come to know the scope or the value of the advice being delivered to them.
The commission compensation model has always run with flaws. The consumer did not have a choice before and the level of commissions has never been in sync with the advice being delivered. Today the choice has come to the consumer wherein he can be told – ” You have a choice to either get advice from an advisor wherein the manufacturer will pay him with or without your knowledge OR you pay to the advisor and receive the services to the level of fee you pay to him/her”. From consumers point the choice of paying the fee works better since it makes the scope of advice clear. Lastly, we will see emergence of more low-cost fee options which will bridge the gap for middle-class investors that do not have large assets to start with but need good quality of advice.
The debate over fee vs commissions has gone strong with many countries like UK, Australia, and Canada who are thinking of banning investments advisors from receiving commissions. The rationale is simple that the advice should work in the public interest. In India SEBI has done the same with Investment Advisers Regulations (2013) and no more holsitic advice can be given without obtaining license from SEBI. We have seen emergence of fee only planners with these regulations. It’s only matter of time when we may see rules to declare all the compensation to the consumer. Then lot of questions will be raised for the advice being delivered and the compensation one receives. It’s only a start and as we move ahead the debate will get more stronger. Sooner tough questions will emerge for advisors relying on commission compensations.