A study on investor behaviour sponsored by Foundation of Independent Financial Advisors (FIFA) and carried out by Final Mile, a behavioural research company, finds that direct plan investors eventually come back to their advisors once they encounter complexities in mutual fund investments.
The study examined the willingness of investors to pay for advisory services. “In a cold state (i.e., not in the investment decision-making context) an overwhelming majority of investors preferred to invest directly (cheaper option) rather than invest with their advisor/distributor. In a hot state, (i.e., in the investment decision-making context) their preferences reversed and an overwhelming majority chose to retain their advisor/distributor and compensate for the services,” the study found.
The study said distributors need not panic when/if the customer opts for the direct option; while experiencing the inevitable difficulty in choosing mutual funds and performing transactions the customer is likely to return. “When customers evaluate the ‘sticker shock’ in the context of investment decision-making, they are more likely to stick with the advisor,” the study said.
Another key finding of the study is related to the compensation structure of advisors. Though many investors understand that their advisors receive commission from AMCs, they do not mind paying their distributors for their services as long as such compensation is embedded in the product. “AMCs are sharing their profits with distributors. One advantage of this mental model for investors is that it eliminates the cognitive dissonance associated with fee negotiation from negatively impacting the affective trust relationship between the investor and distributor. This explains the preference for embedded products among retail investors in spite of the availability of the cheaper, direct investment option since January 2013,” the study notes.
However, when investors have been told to pay such a fee separately, the willingness to pay dropped dramatically. This is because the investor considers the advisor fee to be ‘zero’ in embedded products; it shifts from ‘zero’ to a more ‘salient amount’ in the fee based model, creating dissonance, and making the loss seem larger than it is when linked to the total amount invested.
This unwillingness to pay separately is compounded by the fact that advice is credence good, a service whose value is difficult to gauge even after benefiting from it. Hence, investors find it difficult to arrive at a fair price for advisory services, the study noted.