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Business News/ Money / Personal Finance/  Opinion | Why it’s difficult to name five funds to invest in

Opinion | Why it’s difficult to name five funds to invest in

Industry standards will make the decision for an entry-level investor easier

The desire for two funds that will do really well is an entry point for investors (Photo: Mint )Premium
The desire for two funds that will do really well is an entry point for investors (Photo: Mint )

The problem with getting a message on the phone that demands an instant list of five funds to invest in is that there are no ready names to give. Likewise, for tweets and other social media requests for names of two or three funds to invest in, there is no easy answer. Similar is the problem of somebody asking for a life insurance or a health insurance plan—how does one recommend a single product to a person who knows something about the product but not enough? They don’t know that anybody who takes the risk of advising without knowing more is not acting in their best interest. Mutual funds and individual insurance products have made it into the attention spectrum of the financially included, mostly urban middle-class Indians, but the on-boarding is still difficult, precisely because each person needs a unique solution according to his or her personal situation, goals, risk capacity and profile, but is unwilling to pay for advice and is looking for a quick solution. But there are no quick solutions in personal finance and most people find that the hard way.

On the investment demand side, there is an understanding that mutual funds are an option now, but beyond that very few people really understand how to use them. The first level of understanding is that these are vehicles for a “better" return. And in search of this “more better" return, potential investors look for names that offer this return. They are yet not aware that “better" is not enough, and that one or two funds do not do it. They don’t get the fact that you need a portfolio that looks after your short-, medium- and long-term needs and that the funds in this portfolio must carry different levels of risk depending on the holding period and risk-taking ability. The desire for two funds that will do really well is an entry point for investors. It is up to the supply side to take this demand and turn it into a lifelong approach to investing that looks at goals and their completion using a portfolio of funds. On the insurance demand side, there is an understanding that life insurance is not an investment and that a medical insurance policy is a must-have product. But again, the deeper understanding of being able to choose a product is missing. For example, how many people know that the cheapest plan is not the best or that a medical test pre-policy is really in your best interest? Ideally, the intermediary should fill this need, but they are conflicted between earning the highest commission and their fiduciary duty of putting the customer first.

The supply side has plenty to offer but is waiting for the demand side to educate itself in the nuances of portfolio construction, asset allocation, real returns and a post-cost IRR (internal rate of return) number. Or is happy, as in the case of insurance, to continue with obfuscation to hoodwink the customer. The financial industry looks ready to spend on investor “education", but in many instances, the money spent goes into product pitches or into the pockets of the distributor. Of course, there are some really good real education efforts in play that do carry the intent of true investor education, but they are more the exception than the norm.

So there is real demand and there is plenty of supply, but the market is still seeing a gap. On the investment side, the investor needs an easy way to on-board a simple portfolio that solves some basic issues without putting herself at undue risk. A possible way to bring demand and supply closer together can be better packaging of products in the market. Other than the DIY investor and the advised investor, most others are just looking for a fund for their long-term money. They have heard that in the long term, the market will do well and want a way to on-board. We could address this need by “funds-in-a-box" approach. Put passive funds (index funds or exchange-traded funds) linked to specific indices with a cost, tracking error, impact cost ceilings in place that can then be recommended off the shelf with no conflict of interest. Passive funds are an obvious choice since they take away the fund manager risk and allow the investor to simply ride the market index.

For example, an index fund on the Sensex and Nifty 50 is a low-risk way to ride long-term market growth. Indexing on a mid-cap index and a small-cap index will be a lower-risk way to benefit from the growth in these sectors than buying a managed fund. An investor who identifies herself as a medium-risk, long-term investor could then use a mix of these passive funds. Similarly, if there could be generics in the life and medical insurance space that could be put in such a box, it would improve both financial inclusion and the ability of an average non-advised person to on-board the formal financial sector. Such people could then move up the value chain or stay with what they have, depending on their ability to do-it-themselves or find a good fee-for financial planner.

There are already robo advisors trying out a variant of this model. There are also established distribution houses doing this. But an industry standard that is put in place either by the regulator or an industry body will make the decision for an entry-level investor much easier.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation

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Updated: 13 Nov 2019, 05:30 AM IST
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