“Boy! You just hit the jackpot! You are finally a centimillionaire! (and that too in dollars). All these years of hard work have finally paid off! Now, it's time to set up a great team at your startup, buy that yacht and unwind in the Caribbean.”
While sipping a cold one in the Caribbean seems well deserved, what you may not realise is that your problems may have just become bigger.
We all emphasise on becoming wealthy, but the more crucial aspect of staying wealthy via financial management is often ignored. Everyone knows to be wary of fraudulent schemes such as the Ponzi scheme or the Pyramid scheme, yet people continue to fall for such frauds, which are evolving with time. As recently as December 2020, the Enforcement Directorate arrested 3 promoters for duping investors of Rs 6300 crores in a Ponzi related scheme.
If you think you are safe because you are getting financial advice from a famous financier, think again. Bernie Madoff, who was once the chairman of the NASDAQ stock exchange, pleaded guilty in 2009 for running the world’s largest Ponzi scheme worth $64.8 billion. So knowing whom to trust with your hard earned money is very critical in your path to financial success.
While many do a stellar job of managing their own finances, some of us need the support of professionals to make critical financial decisions. Therefore, before you embark this financial journey with your trusted financial advisor, you should ask them some tough questions to know if they are truly on your side.
“So… how exactly do you make your money?”
“Does me buying this instrument influence how much you earn?”
“What are your Key deliverables?”
“Umm… actually it's super complicated. There are multiple variables at play and it also depends on the market conditions, interest rates, global outlook…blah blah blah...”
If you get the above answer, be wary of the fact that your financial advisor is not being completely open with you.
Transactions: Transaction based fees structure generally comprises a fixed value or a percentage of the transaction executed. This fee is generally borne by the investor and is usually the same across all investments.
Quantum based: In a Quantum based fee structure, financial advisors directly charge a management fee from their clients. This fee generally comprises a fixed percentage value of the assets under management and may also include a performance based amount. If a financial advisor is managing a portfolio worth Rs 10,00,000, he or she could charge a management fee of Rs 5000 (0.5% of Assets under management).
Commissions: In this arrangement, a commission is charged when they recommend and sell specific financial products, such as mutual funds. For instance, if you invest 10,000 Rupees in a Mutual fund that your advisor recommends, he or she receives a commission fee (say for example 1%) of 100 Rupees from that fund house.
Profit-Share: In this fee structure, the investor has to pay a share of the profits earned to the wealth manager (typically around 20%). The payment is made only when the returns are above a certain threshold rate, which can vary between 6% and 10%. In this case, the onus is on the wealth manager to generate returns.
Although all these fee structures are generally the accepted norm, delving deeper into the fee type will help you identify the true incentive of your wealth manager. For instance, in a Transaction based fee type, your manager gets paid a certain percentage of each transaction; therefore he or she has incentive to undertake as many transactions as possible even if the transaction is detrimental to your portfolio. Similarly, if your advisor is paid through commissions from a Fund house, he or she has incentive to invest your money with a fund that pays the most commissions rather than a fund that performs the best. A wealth manager whose earnings are dependent on how much your portfolio grows will always have incentive to make you the most money. Therefore, a fee structure that is inherently aligned to make your portfolio grow could be ideal for you.
Whatever the type of fee structure, choosing a wealth manager is like choosing your life partner. You will have to trust their judgement and take calls based on their inputs on both good and bad days, and these decisions might affect you for the rest of your life. Trust is key in this relationship, and hence, it is important that you choose the right financial advisors only after you are completely sure that they have your best interests in mind.
Author: Team dezerv.
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