Paying for the Right Advise

The fact that Fees eat up returns is well known and yet there persists an idea that somehow Indian funds are different and that even though they are charging a bomb to manage money, all is well. This undying spirit is being broken as with new regulations, Active funds will find it difficult to beat the indices without doing things differently which in turn can expose them to short term under-performances that don’t easily go well with investors and advisors alike.

We pay fees in many ways – some like in case of doctors and lawyers directly and some like mutual funds indirectly. But pay we must to grease the system on which it runs for there is nothing like a free lunch. This blog may seem free but by spending valuable time which could have been spent elsewhere you are making a payment to me.

Save More, Spend Less is an age old adage that will never get old. The only sure path to savings is by spending less. Spending less doesn’t just mean about cutting down on non-essential spending but also scrutinizing spend in case where it’s not directly visible.

Selling fixed deposits of Banks will not yield you any commission, but Selling Fixed deposits of private companies yields a nice little commission.  The reason is not far to seek – Fixed Deposit at Banks doesn’t need selling – it’s a pull product. Since Fixed Deposits at a private company aren’t in the same risk bucket as Banks, they need to be sold – they can be seen as Push Products. Without the guy to push, you on your own may not be willing to park your excess money even though the interest rate looks attractive.

In the world of Equity Investing, Direct Investing is more of a pull product. Stock Brokers have strict regulations when it comes to advertising and with they being nothing more than a conduit to invest in the stock markets, rare are those who actually go out and advertise.

But when it comes to Indirect Investing, the product now becomes a push product. It doesn’t matter how good the product is, if there is no one to push it, the product may soon become irrelevant. Exchange Traded Funds are disliked for the simple fact that no one gets paid to sell and hence if one were to ignore the investment of the Pension funds, the total asset under management is less than what Mutual Funds as a whole gather every month these days.

While much of the world is moving towards paying for advise, our inability to overcome the hurdle of having to pay separately for advise leads us to paying a much bigger fee for advise that may actually be not worth paying for.

Over the last few years, we have seen a mushrooming of fintech companies {so called because they combine finance with technology} who provide an ability for investors to buy into mutual funds.

Recommending funds isn’t as tough as it’s made out to be. Select the top fund houses, select their top schemes and you are more or less done with the shortlist of funds available for investment. Final addition would be to maybe mix and match different market styles so that one has exposure to Large, Mid and Small Cap.

The bigger problem and one that is worth paying money for is Allocation – how much should you invest in Equity and how much in Debt. The percentage should be based on your risk profile, your requirements and finally your ability to stay with it during the bad times.

The best allocation would be one that has the lowest risk and yet meets our goals without one having to sweat it out. If only life was as simple as tweeting or blogging.

Harry Max Markowitz won the Nobel Prize in Economic Sciences for his work in modern portfolio theory, studying the effects of asset risk, return, correlation and diversification on probable investment portfolio returns.

While the theory is cool, it’s practically impossible to come up with the optimal portfolio alloction given the constraints of having to know literally the impossible. So much so, when asked about his own portfolio allocation, Markowitz is supposed to have replied

I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.”

Knowledge of complex mathematical numbers in itself is meaningless if we are unable to control our emotions and no matter how strong we feel we are, we all panic if we have positions that are higher than what is comforting.

Few days back, Josh Brown of the Reformed Broker fame had an interesting blog on “What People will Pay for”. I urge you to read that.

Josh is the CEO of Ritholtz Wealth Management and the stuff they do is not trying to pick the best mutual fund or ETF out there. Compared to India, they have a plethora of options out there, so the focus for them is fees.

At the lower end, they charge as much as the distributor of the mutual fund gets here – just that rather than just pointing at the right fund, they are willing to stick their neck out and provide an asset allocation plan that is suitable for the customer.

10 years back, markets at the current time were on the way down, a month from now, they were spiraling out of control before they finally bottomed one fine day in October. By the current time in 2008, Nifty 50 was down 32% from the peak.

The best fund from that point to today was DSP BlackRock Small Cap Fund which over the last 10 years has given a compounded return of 20.36%. But how many advisors would have advised to buy such a fund and more importantly, advise you to invest enough to make a difference to your Net worth?

If I filter for all funds that today have more than 1000 Crores in Assets ignoring all sector / thematic / ETF’s and Index funds, the Median return drops to 14.40%. Asset weighted return comes in at 15.20%.

Nifty 50 Total Returns for the same period comes to 11%. Choosing other major indices could have given higher returns, but the point as I wish to make is not about returns.

A couple of weeks ago, I ran a poll on how often investors measured the growth of their net worth. Given my inclination to tweet slyly and sarcastically, I wonder if that had an impact for the majority claimed to do it on a daily basis. Literally none of them said Never.

But honestly, do you know how much your net worth – liquid that is – grew in 2017 or has grown in this year? While we measure every other thing to the second decimal, it’s surprising to me that most don’t bother with the growth of their net worth.

Growth in liquid net worth is directly dependent on the split between equity and debt. It doesn’t matter if you have the best mutual funds out there if they constitute just 10% of the total net worth for the end result will be worse than someone who has invested 50% in Nifty (which as per data above is close to 45% lower).

Advisors are dime a dozen – but how many are willing to sit with you, talk through your fears, your goals, your savings and the devise the asset allocation that suits you and the plan you need to follow to get to the goals you have in mind?

Asset Allocations can either be dynamic or static. For long, at this site I have been publishing an Asset Allocation Mix that one could reference as a guide to how much to be invested in the markets. That is a form of Dynamic Asset Allocation.

On the other hand, Harry Markowitz follows what can be seen as a Static Asset Allocation. Both have their advantages and disadvantages and its important to understand what suits your style of investing, your risk temperament before deciding on one or the other.

This is what you need to pay an advisor for. This knowledge is neither cheap nor easy to obtain for it requires one to really understand the ultimate requirement of the client and how best he can be served.

No one knows which will be the best fund with 10 year returns in 2028, but with a good asset allocation plan, you can sleep well in the knowledge that come 2028, you have a certain probability of meeting your goals if returns are as per one envisaged based on data of the past.

Now, that advise is worth a fee.