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When to fire your financial adviser

In a rising market, investors tend to not mind just getting index returns because these are quite high, but the job of an adviser is to educate you on the higher returns that managed funds must deliver to justify the higher costs

I am out for a Saturday lunch with the husband and his friend. They meet regularly to argue over whether RD (Burman, not recurring deposit) was God. They almost cause a riot arguing about Bappi Lahiri (don’t even ask). Soon, sanity comes along with the food and the conversation turns to the friend’s portfolio (thank you, God). He is using some adviser who floats around in his office and seems pretty happy with him. I ask a few questions and feeling a bit like Gregory House (those who watch the TV series House will get the reference), I set out to destroy his warm, fuzzy feelings towards a guy who is obviously incompetent.

How did I come to this fairly harsh conclusion? I asked a few questions—maybe a good idea to ask your ‘adviser’ similar questions to see if your guy is really the one. I asked him when he began investing. He began a year ago—he is risk-averse and worked to clear his loans before he began investing. Different strokes for different folks, and at his age, stage and income, keeping a part of the home loan may have made sense, but if he sleeps better debt-free, then that is what he should do. But the next question is linked to the age of the portfolio. I next asked him about his portfolio’s returns.

He did not know and said he will find out. He came back with a number that looked a bit low to me for a 1-year return. And the number had equity and debt mixed—not a problem except that the adviser should have disclosed the two asset class returns separately and given a portfolio return. Think of it this way: suppose you’re going from Delhi to Puducherry —you do Delhi to Chennai by air and Chennai to Puducherry by taxi.

Now you’re asked what was your speed for the journey, will you give the average speed or the speed of the aircraft and taxi separately? Even though you may think of the average, you know that the speeds of the two modes of transport are different and won’t blame the taxi for not matching the speed of the aircraft.

An adviser who gives you the average without separating out the asset classes when disclosing returns needs to be questioned. I also found that his equity was doing Sensex return. If you have managed funds (as opposed to index funds), and you are just matching the broad-market index, it is a red flag.

I next asked him how many funds he had. He had 23. I looked at the names: the ‘adviser’ had bought everything in the market. A mix of micro, small, mid-cap, large-cap, sector, rural, banking, multi-nationals, emerging, logistics, pharma —unlike the pizza with everything on it, a portfolio with everything on it is just expensive without giving you a return kicker. Check your portfolio—if you have more than a total of 10 funds—across all categories—you need to question your adviser.

The reason is this: you buy two funds from each category to diversify your portfolio, or to reduce the risk of one fund not performing well. When you buy more than 10-12 funds, you tend to get average benchmark returns. Targeting benchmark returns is a good strategy, but then you need to buy exchange-traded funds (ETFs) and not managed funds. It costs you less than 7 paise on every Rs100 that you hand over to the fund in an ETF.

It costs you an average of Rs2 for every Rs100 in a managed fund. If average Sensex return is what you want, why pay for the additional risk and cost that a managed fund brings? In a rising market, investors tend to not mind just getting index returns because these are quite high, but the job of an adviser is to educate you on the higher returns that managed funds must deliver to justify the higher costs. So if you see more than 10 funds in your portfolio, start doubting what your ‘adviser’ is doing and compare equity return with Sensex return.

Next, I asked him if the adviser was ‘switching’? Yes, a few times. In a portfolio that is 12 months old, the adviser must have made wrong choices if he needed to churn the portfolio already. Ask for the details of what is sold and what is bought from your adviser. If you see funds being recommended for a ‘sell’ within 2 years of being put on the buy list, ask why. There could be a genuine reason—such as a fund house sale or the exit of a star fund manager —but it could be that the guy is churning you; maybe to win a junket his fund house is offering.

My advice to the friend is to fire the ‘adviser’ and either go direct or look for a full service financial planner.

End note

The market regulator is tightening the rules around who can call himself adviser and will release a consultation paper to think through the amendments on the 2013 Investment Advisers regulation soon (read about the announcement here: http://bit.ly/2cVr6Wt ). The aim is to rethink whether mutual fund distributors can ‘advise’ investors as part of their sales process. Ideally, all financial sector regulators should put their heads together to have a single set of rules for investment advice. But that is another conversation.

Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint, consultant NIPFP, member of the Financial Redress Agency Task Force and on the board of FPSB India. She can be reached at monika.h@livemint.com.

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