The incentives provided to Mutual fund and Insurance agents are all warped, and actually hurt the industry more than anything else.
Agents get a commission immediately after selling a product. This is charged to the customer as either an entry load or a premium allocation chart. While agents get “trailing commissions” – or a part of the total money every year – this is very little money and therefore the agents don’t really care about it in comparison with the upfront loads.
Which means it incentivises agents into doing stupid and potentially fraudulent things.
Like, Lying to investors. Many agents routinely misinform investors about schemes – saying that their money is guaranteed when it is no, telling them that a certain % return is “definite” and hiding information about loads and commissions.
Agents also refuse to compare products. For insurance agents this is understandable as they can only sell one company’s products. Mutual fund agents don’t have this problem, but they either refuse to compare, or simply provide non-verifiable parameters to sell the products of their choice. Like – Sir, this fund is good because I heard it will give dividend very soon.
Many agents also confuse investors into listening to them. I don’t blame them for not educating investors – if people get educated they can ditch the agents completely, the system is that easy. But I do blame them for confusing them – and the underlying companies help. By providing options like “SIP, SWP, STP, Dividend, Growth, Bonus, Quarterly something, Annuity based something else” etc. The agents then latch on to inconsistencies in literature and hard sell a product – for instance, many agents sold LIC’s market plus as a product that guaranteed 25% returns every year, when some silly bloke had made only an illustration of how the product would grow if it should return 25% a year.
The incentives therefore need to be changed. I suggest zero upfront commissions (and therefore, loads). This is possible right now with “direct” investments in mutual funds – but not with insurance products.
And then commissions should be back-loaded. Maximum commissions for a 20 year insurance product should be in the 20th year (or a prior exit). For mutual funds, pay commissions at the end of a year of investment (for equity).
In the end we should all be able to buy these products online or by direct investments. Agents should be able to charge a fee, billed separately from investment, so that people know what they are paying and demand appropriate service. It may not happen in my lifetime, but I think we are slowly starting to get there – in a few years, we’ll revisit and see if something radical has happened.
But remember – in the end, it’s about how we, as investors, choose to educate ourselves. Regardless of what some agent tells you, if you go and buy a product that takes 70% upfront commissions, you are stupid, period. Can’t go around blaming the brokers for this – you have to take responsibility. But we have to change the incentive model, or live with biases, lies and frauds forever.