Pain of paying – the psychology of money (revisited)

I have been writing/blogging about the proposed regulatory changes regarding mutual funds and financial advisor remuneration since early 2013. Back then, regulators were telegraphing to the industry that commissions would be “targeted” for reforms. Although commissions were fully disclosed in writing, most times regulators were in favour of “direct pay” models that the UK and Australia were employing. In those countries, commissions were replaced by direct fees or bills that investors had to pay separately.

I objected to the proposal citing research about the possible “pain of paying” impacts on investors.

I recommended that we should retain what we have now - a two model system; embedded commissions and/or “direct pay” fee-based.

Years ago I bought Dr. Dan Ariely’s best seller book called “Predictably Irrational” and came across his videos on his website.

This video; inspired me to associate the “pain of paying” concept with the threat of unembedded commissions and replacing them with a “pay direct” model.

The regulator prefers to use the term “pay direct” or “direct pay” but I prefer to use the term most investors would immediately think of – “I have received a huge bill!”

This ties in very neatly with my hypothesis at the time that “pain of paying” behavioral concepts would apply directly to the possible banning of embedded commissions and that the unintentional consequences could be severe.

I have done some additional research lately because I think there is more to it than just embedded versus unembedded arguments.

Investment Counsellors often have no trouble whatsoever handing a High Net Worth (HNW) client a bill for say $10,000 a year on a million dollar account and their clients seem willing enough to pay. So if that is the case, why would mutual fund investors recoil in horror at the prospect of direct billing?

Good question.

Again Dr. Ariely’s video provided me with another clue when I bumped across some of his recent research on his “pain of paying” theory. Dr. Ariely goes on to explore an important part of the “pain of paying” equation that I had briefly touched upon in my 2013 article1 but didn’t realize how important it was at the time.

Dr. Ariely says the “pain of paying” is magnified to the nth degree by moving from a perception of free to something [painfully] quite higher.

Therefore raising a cost or price or fee of $0 to $1000 is infinitely more painful than raising costs from $1000 to $2000.

Although Investment Counsellors typically charge staggeringly high fees, why do their investors pay so willingly?

The answer is simple – those investors typically never had to deal with change. They’ve generally had to pay discreet fees right from the beginning.

I contacted Dr. Dan Ariely and asked him what the specific impacts on investors would be if investors in Canada were billed separately for their investments.

Dr. Ariely explained that if a client who has $1 million dollars invested in a savings account, for example, and pays 1% asset under management a year usually doesn’t express any concerns. However, Dr. Ariely argues that if a client had to directly pay $10,000 a year, they probably wouldn’t do it. The reason is that people may not seek advice if they have to pay for it directly.

Therefore, according to Dr. Ariely, if Canada bans embedded commissions and starts to bill investors directly, investors may refuse to pay, and if they do they will be upset. Investors may not seek advice, may stop investing or may not be put in the correct investments.

Up to this point, most references to unintended consequences refer to consequences that are relatively minor. Unfortunately, Dr. Ariely suggests otherwise.


1 Adviser fees – the pain of paying

Glenn Szlagowski is a Financial Advisor at Assante Financial Management Ltd. in Kitchener, Ontario. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.

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