What is the difference between fee-only and commission based advisors?

There is a lot of confusion about the fees paid for financial planning services in India, mostly because there are a variety of business models, each of which charges clients in different ways. Below are the 3 popular models. You should always confirm this with your advisor before you start working with them.

Commissions

In this model the advisors earn commissions based on the financial product (MF or insurance) purchased by you. Such advisors are commonly known as distributors. Distributors do not charge anything upfront to their clients. Distributors receive commissions from the fund house or insurance company, depending whether you are buying mutual fund units or insurance policies.

How much do you pay as commissions?

If you purchase units of HDFC Small Cap Fund, then HDFC AMC (the fund house) which manages this fund will pay commissions to your advisor. Average commissions are 1% for equity MFs and 0.5% for debt MFs. A 1% commission would mean that you would be paying Rs 10,000 for every 10 lakh invested. Note that these commissions are not dependent how the MF is performing. Read: Can you explain expense ratio in simple language with a numerical example?

Trust factor is important in this case because some (not all) advisors could promote products which fetch them high commissions. So only work with advisors, whom you trust to take decisions in your best interest.

Fees

Advisors who charge fees can do it in 3 ways:

1. Percentage of amount invested (Fee Based) 
2. Fixed fees (Fee Only).
3. A combination of the above 2 methods. Eg. Fixed fee upto a certain amount of investments and % fee on subsequent amounts.

Fee Only

A fee-only planner is someone who charges a upfront fixed fee for financial plan creation and advisory and does not receive any kind of commissions/incentives from mutual fund houses, insurers or other financial product sellers. Please note that the words "fixed fee" are important over here, the fees are not linked in any way to the amount being invested.

Typical Fees

Fees could vary, from as low as Rs 7000 to Rs 18,000. This will depend on the level of experience, number of clients, track record of the advisor and the complexity of your requirements.

Fee Based

This is similar to the fee-only model, only difference being that the fees are a percentage of the amount being invested. 

The difference between fee-based and commission based models is that in fee-based model the advisors earn their revenue directly from the client, whereas in commission based model the revenue is earned indirectly from mutual fund houses.

SEBI Registered Investment Advisors (RIA) are bound by SEBI regulations to work on a model where they earn their fees directly from the client and not from the asset management company (mutual fund house) or insurance company. So SEBI RIAs work on the fee-only, fee-based or a combination of the 2 models.

Investing Process - Fee Only vs Commission Based

A commission based advisor will manage investments for you i.e. they will:

• Take care of KYC and documentation - for both mutual funds and insurance
• Setup SIP amounts for mutual fund investments. They typically use a software tools to manage the SIP amounts for their clients.
• If you want to increase/decrease the SIPs then you will have to ask the advisor to do that for you.
• For insurance they will assist you in filing claims and communicating with the insurance companies.

Fee-Only advisors will NOT manage the investments for you. All the documentation, KYC, account opening etc has to be done by you. Typically they will give you a financial plan, which will list out all the investments to be done. How you make these investments is upto you. You can choose a platform or distributor of your choice. Typically, fee-only advisors will recommend 3-4 direct buying platforms so that you don't have to pay commissions.

Portfolio Reviews - Fee Only vs Commission Based

Portfolio review is typically required once in every 6 months or once every year, depending on your portfolio. The advisor will re-evalutate all the assumptions and projections made in your financial plan, let you know if you need to increase/decrease your investments. They will also tell you if you should continue with the funds in your portfolio or switch to other funds.

Fee-only advisors typically do an annual review and charge between Rs 5,000 to Rs 8,000, for the review.

If you have a commission based advisor and if you continue to invest through them, then they are supposed to do this review without any additional cost. Please note that I have emphasized on the words 'supposed to'. There is no guarantee that they will do it. Good advisors will do it. You should always confirm this before you agree to hire a commission based advisor.

DhanWise Opinion

We do not favour one model over the other. Both the models have their pros and cons. We want to educate people about these models and enable them to make a choice depending on what works best for them.