For one thing, most people do not act rationing when come to judging how “expensive” or “cheap” a financial product or service is. The plain mathematics of $2 is more dear than $1 is not applicable in most cases sometime it is because the product involved is not straightforward but most of the time it is because client does not act logically.

Take for instance, which is more expensive: a $5 apple or a $6 buffet? Firstly, the question is itself not logical. How can anyone compare an apple and a buffet? These are not the same thing and hence have no basis of comparison. Yet it is often the case that clients ask to compare the cost of signing up an investment portfolio management service and the cost of purchasing investment products (e.g. unit trust) from online portal. The comparison in this case is like comparing an apple and a buffet lunch. They are not the same. Does online portal do any fact finding? Does online portal provide any advice? Is the online portal licensed to provide investment advice to individuals? Similarly, does the financial adviser in the business of selling products as a wholesaler? No no no of course. So there is no basis of comparison. Thus, it is meaningless to talk about cost.

Back to the apple and the buffet. The apple cost $5 and the buffet cost $6. Some clients like to compare the numerical figure. Mathematically $5 is less than $6. But we know from commonsense that the apple is expensive and the buffet lunch seems a bargain. Thus the second illogical reasoning that people often commit is to look at the numerical figure of the cost tag to it without really understanding the underlying. Take for instance, in this blog entry here http://www.wilfredling.com/content/view/305/9/ I mentioned about a regular premium ILP that has no apparent sales charge and in fact gives up to 62.5% in extra premium in the first year. If compared to a plain vanilla unit trusts with sales charge (and wrap fee), which is more expensive? On the surface the unit trusts seem more expensive since it has sales charge and no “extra” premium. However, in reality the ILP is much more expensive.

Related to the above paragraph, many clients do not mind embedded cost but dislike financial advisers who are more transparent with fees. I for one prefer to be transparent about fees but apparently many clients hate it. I did a simple experiment recently. I showed two choices for a high networth client. One is a hedge fund with an estimated expense ratio of at least 5% pa on average. Another is a portfolio of ETFs that have less than 2% expense ratio (including all “hidden” fees). The client sign up with the hedge fund. Why? It is because the hedge fund embedded all fees. There is no apparent “sales charge” and no wrap fee. For the ETFs portfolio, I have to disclose my portion of the fees since the ETFs fund managers do not pay us commission. Why then do clients buy the more expensive choice? Perhaps it is because they think embedded fee means no fee; perhaps they dislike to pay any fees to the financial adviser. The lesson is that the decision made was not logical at all.

Sometime clients save money in one area without realizing that they lose a lot of money because they have to spent time “saving cost”. For example, I encountered a highly paid businessman who keep on worrying about whether to buy a unit trust or an ETF. I told him just go for the ETFs and leave the rest to me because I’ll construct a diversified portfolio from reputable index fund managers, eliminate estate duty problem and probate and all those irritating problems. But he decided to DIY.  I think finally he decided to buy a unit trust from online. But the time that he has to spent making that decision and also monitoring it and as well as all the reading up takes away so much of his time from work that he is losing a HUGE amount in opportunity cost because he had to neglect his business. Of course in my opinion he made the wrong choice because an ETF portfolio is better than that particular unit trust he has chosen for himself. Why he didn’t engage my service? Perhaps partly because he didn’t want to pay me fee and partly because it is perceived that DIY is cheap. I am afraid for this person he is greatly mistaken.

If clients do not bother about making logical reason, why than do I bother even to write about this? The reason is simple. There is no free lunch. Products that are perceived to be “cheap” to the client but in reality expensive will eventually show its ugly horns. The investor will eventually realize that the return over a long term basis is lousy. Was it common to hear people complain that their XYZ product they bought cannot perform? Who is to blame? There are two parties to blame here. The underperforming fund is the obvious culprit. However if the client makes decision that favors expensive products due to his illogical reasoning, who than is the party who is really to be blame? It takes two hands to clap as the saying goes.

In the meantime, financial advisers who are “punished” for being too transparent with their fees because clients dislike transparency, will eventually sell products with high embedded cost. The commission is good and the client loves it. Who is at the losing end here?