March 2012

Let’s take you into the business model of a financial planning / wealth management (FP/WM) company and prove as to why if you are not ready to pay for advice given by such companies, you will eventually be mis-sold some products. This is almost akin to the computer industry in which haggling over hardware price may lead to your ending up paying more for the software throughout your life. Or buying a cheap printer may consign you to a life full of expensive cartridges. Or worst, doctors making money from drug manufacturers and pushing their products if you haggle over their fees (hypothetical situation, but brings out a scary parallel to the FP/WM industry).

What constitutes an FP/WM company ?

An FP/WM company is a collection of Relationship Managers (RM), fronting the relation with Clients like you, and delivering financial advice. This advice is developed after lots of products research by a Central Team comprising Investment Advisory team as the backbone. And enabled by Operations, HR and Marketing Teams. This overall effort is synchronized by the senior management team.

The business requirement from an RM

The RM has to bring in revenues to adequately take care of his cost to company and cost of Central Team, leaving enough portion of revenues as the profits for the firm. Typically such businesses target 3 times cost of RM as revenue to be brought in by each RM, so that one-third of revenue goes into the CTC (cost to the company) of the RM, another one-third to cover costs of Central Team and office costs, and the last one-third is profit of the firm. Hence, if the cost to company of an RM is Rs 5 lacs p.a., each RM targets to bring in Rs 15 lacs of revenues p.a. to survive in the system.

Now, it’s been empirically found that each RM can typically manage maximum 40 clients before she starts slipping on her servicing commitments. Hence, to get her Rs 15 lacs p.a. revenue, each client needs to give Rs 37,500 p.a. revenue. Revenues come out as commissions from product providers, typically at 1% of assets invested. Hence, each client needs to give our RM Rs 37.5 lacs of assets, a very tall order. What typically happens is that an RM at this level manages to get Rs 15-20 lacs of assets from each client and hence falls short of revenue targets by 50%, i.e. Rs 7.5 lacs p.a.. The RM tries to increase revenues by either increasing commission from 1% to 2% by selling some (exotic) products which give her more commission. Or some RMs increase clients handled to 80 and end up doing a shoddy job of responding to your queries and requests.

So, what does a smart FP/WM company do ?

Some smarter FP/WM companies have realized this self-fulfilling predicament of “eventual bad advice” and insist that each client pays Rs 15-20,000 p.a. as fees for an elaborate financial planning exercise or wealth review exercise and for hand-holding in execution of the investments. This takes the pressure off the RM to look for devious ways of increasing commission revenue and ensures in her giving prudent advice to the clients.

I am happy with my “small” neighbourhood financial planner

One thought emanating from above discussion would be to go to firms who do not have a need for covering cost of central team with one-third of revenue, viz, your friendly neighbourhood Financial Planner or Independent Financial Advisor (IFA). But then again, you will get what you pay for (or in this case, what you don’t pay for). To give the quality of advice which any serious portfolio of more than Rs 10 lacs deserves, the FP/WM firm needs to have an Investment Advisory team, which researches stocks, mutual funds, bonds, structured products, PMSs etc. To give you your multi-asset statement and on-line access to your wealth status, the FP/WM firm needs to have an operations and technology team. To give direction on overall asset allocation and to ensure that risks are taken care of, the firm needs senior management.

To make 33% profit after covering the cost of such a central team for a national FP/WM company, and with RMs of Rs 5 lac CTC, such an FP/WM company needs 95 RMs !!

Conclusion To get good advice over long run, you need to be advised by companies which have the wherewithal to do intensive research and come out with smartest advice suited to your circumstances, and which have the resources to give good operations support. To cover costs of such set-ups, your Relationship manager needs to make three times his salary as revenue. To make this revenue and to service a manageable set of clients in a proper manner, clients with >Rs 10 lacs assets need to pay Rs 15-20,000 p.a. as fees for getting financial planning done and for “door-step” execution of investments. Anything less than the above may lead to RMs pushing products with higher commissions to meet his revenue targets, howmuchsoever the FP/WM firm puts restrictions on implementing norms of “right products for right clients”.