In a recent adjudication order against Indore-based Star India Market Research, an investment adviser registered with the Securities and Exchange Board of India (Sebi), the capital markets regulator highlighted a series of malpractices that violated the Investment Advisor Regulations of 2013. The firm in question not only recommended high-risk products to individuals who were too old or too inexperienced to be buying them but also pushed products designed for high net-worth individuals (HNIs) to people with incomes of ₹1-5 lakh. Also, it charged customers twice or more for the services rendered.
Unfortunately, this is not a one-off case, and gullible investors often place their trust in advisers who do not suit their needs. With a plethora of financial advisers—from banks, insurance and mutual fund companies to registered financial advisers—available in the market, choosing someone who has your best interest at heart is difficult, but essential. How advisers answer some key questions can help you understand their intentions, to some extent. Here are five key questions you should ask before hiring an adviser.
Is the adviser disclosing how he is being paiD?
A mutual fund distributor is paid a commission, which is a percentage of your investment. The commission is paid to the distributor by the fund house and varies from one fund house to another. In other words, the investment recommendation can be influenced by the commission the distributor is getting. Similarly, an insurance agent is paid by the insurer. A Sebi-registered investment adviser, on the other hand, charges you a fee and is supposed to act in your interest alone, although this may not always be the case.
Before approaching intermediary, whether it’s a distributor or adviser, or during the first meeting, ascertain how he or she is being paid. If an adviser says his or her service is free or is not transparent about this disclosure, it should be a red flag for you.
Is he focusing on you or the product?
A good adviser needs to spend time understanding your financial circumstances and your goals.
“Does the person put the product at the centre or you, the client?" asked Mrin Agarwal, founder director of Finsafe India Pvt. Ltd and co-founder of Womantra. “This is a key distinguishing factor. You should also see if he is talking long term or short term. Typically, a slick operator will talk about returns in one to two months or less," she said.
The financial adviser needs to ask you about your dependants, your expenses and also what you are investing for. He needs to understand your risk appetite and ability to withstand losses. It is only after knowing all this can a suitable investment be recommended. Any financial adviser who tries to sell a product rather than understand your financial needs is not the right person for you.
is he promising unusually high returns?
A high and guaranteed return such as “12% risk-free" is a red flag. However, many investment advisers skirt such obvious exaggerations in favour of more subtle but unreal claims.
Recently, a fund house sent out emails prominently showing 13% as the “maximum" annualized return by its liquid fund over a carefully chosen set of dates. The fund house was clearly trying to induce people to invest by working a high figure into an email about a product that ordinarily gives 7-8% or even less. If an adviser says something like you will get 15% return by investing in a mutual fund, you should question it.
Is he talking enough about risk?
While everyone talks about returns, few mention the associated risks. Remember that risk is the other side of the investment coin and making clients aware of the risks of investments is an essential part of financial advice. Some advisers skip this part or rush through standard questions in order to check the right boxes for the regulator. If you see your adviser doing that, you must stop and ask him or her to explain the various types of risks involved.
In its adjudication order against Star India Market Research, Sebi found that the firm had recommended market-linked products to persons aged above 80 years, paying scant regard to the risk appetite of investors.
Is he suggesting complex investment products?
You should view an intermediary who suggests exotic or highly complex investments without adequate explanation and justification with scepticism. Typically, this is simply a result of getting higher commissions in these products. “If the financial adviser is recommending an unregulated product like Bitcoin or a product outside his mandate such as real estate, it should be a cause for concern," said Kalpesh Ashar, proprietor, Full Circle Financial Advisors, a financial planning firm.
The task of finding the right financial adviser needs to be taken seriously because it is the first step towards putting your investments in order. Relying on someone’s brand is not enough. Check the person’s responses to the above questions before you place your trust and money in his or her hands.