Be aware of the incentives driving the person selling you a financial product
Why Knowing Seller Incentives Matters Before Buying Financial Products
You’ve probably heard the famous saying: “There’s no such thing as a free lunch.” In the world of personal finance, this couldn’t be more accurate. Whenever someone is selling you a financial product, chances are they have their own incentives that may or may not align with your best interests.
Let me share a real-life story that highlights this issue. It’s about my neighbor, Sunita, and her first experience with mutual fund investing.
Sunita’s First Step Into Mutual Funds
Sunita is a 40-year-old woman living in a tier-2 city in India. Like many people who want to build wealth, she had been hearing about mutual funds as a great long-term investment option.
Excited to begin her investing journey, she walked into her trusted local bank to ask about mutual funds.
Now, if you’re used to investing in mutual funds online through mobile apps, you might wonder: why go to a bank? But for millions in tier-2 and tier-3 cities, banks are still the most trusted source for financial advice.
And this is where her story gets interesting.
When the Bank Pushes Insurance Instead of Mutual Funds
Instead of introducing her to mutual funds, the bank manager began recommending a savings-linked life insurance plan. You know the kind—it promises a mix of life cover, return of premiums, and some “investment” return.
Sunita left the bank confused. After doing her own research at home, she realized she only wanted to invest in mutual funds, not insurance. So, she went back to the bank to ask again.
But once more, the manager kept pushing the same insurance policy. And when Sunita firmly declined, the manager’s expression changed. He frowned, clearly displeased.
So why was the manager so insistent on selling insurance instead of mutual funds?
The Incentive Problem: Mutual Funds vs. Insurance
The answer lies in commissions and incentives.
-
Mutual funds (regular plans): Distributors typically earn 0.1%–2% commission on your invested amount. This continues for as long as you stay invested.
-
Insurance products: In many cases, the seller earns a hefty one-time commission on the first year’s premium, which then drops from the second year onward.
The higher commission on insurance policies makes them much more attractive for sellers compared to mutual funds. That’s why many bank managers and agents push them—even if the product doesn’t really fit the investor’s goals.
To be clear, insurance is not a bad product. Everyone should have term life insurance and health insurance as part of their financial plan. The problem arises when sellers push unsuitable or low-return products simply because they earn more commission.
Active Funds vs. Index Funds: Another Roadblock
Sunita, determined to stick with mutual funds, told the bank manager she wanted to invest in them. This time, he suggested active funds.
When she asked about index funds (low-cost passive funds that track the market), the response shocked her: “They aren’t available here.”
In reality, the process of investing in index funds is no different from investing in active funds. So why discourage them?
Again, it’s about commissions.
-
Active funds generally pay higher distributor commissions.
-
Index funds, being low-cost, have minimal distributor incentives.
Eventually, after some back and forth, Sunita managed to invest in index funds. But even then, the process was delayed—it took two extra days compared to active fund processing.
The Lesson: Always Check Incentives
Sunita’s experience is a powerful reminder for all of us. Before investing, always ask about the seller’s incentives.
Yes, it might feel awkward to ask your bank manager or financial advisor how they earn from the product they’re recommending. But it’s an important step in ensuring that the product is genuinely right for you.
Receiving a commission isn’t wrong—it’s how the financial distribution system works. The problem arises when incentives are misaligned with investor interests.
Key Takeaways for Investors
-
Know the product you want. Don’t let anyone push you into something you don’t understand.
-
Ask about commissions and incentives. Transparency is key.
-
Remember insurance is important—but only the right kind. Term insurance + health insurance should be your priority, not savings-linked policies.
-
Explore low-cost options like index funds. They may not be attractive for sellers, but they’re often a smart long-term choice for investors.
-
Consider online investing apps. They often give you access to direct mutual funds (with no distributor commission), which means better returns in the long run.
Final Thoughts
There’s no such thing as a free lunch. Even when you’re paying, it’s your responsibility to choose the product that truly fits your needs—not the one that’s most profitable for the seller.
Whether you’re investing in mutual funds, insurance, or any other financial product, always keep one thing in mind: understand the incentives of the person across the table.
That knowledge can make the difference between a well-planned investment journey and a costly mistake.