Is your financial advisor qualified?

Financial Planning | admin | June 8, 2011 at 8:58 am

Several readers have written in asking about how to make investment choices and how to choose a financial advisor. Many are also worried that if financial goals are not defined or pursued in a disciplined manner, there would be a crisis. While we all respect the doctor's advice on what is good for us, we do not panic about it every waking moment. We all know that healthy eating habits and moderate exercise are what we should aspire for. Investing requires a similar implicit understanding of a framework in which routine decisions can be made, and then seek the wealth manager or financial planner for value addition.

We invest so that we are able to build assets that will enhance our overall financial health. There are three broad categories to choose from—assets that will grow in value over time (growth assets), assets that will generate regular income (income assets), and assets that would preserve value (cash assets). We can argue about the nuances, but this classification is simple and helpful. Every asset would primarily serve one of the three objectives—growth, income or liquidity.

Asset allocation may sound like a technical concept, but every decision we make with money to invest in an asset is an asset allocation decision. When we let money lie in the savings bank account, since we have not made up our mind, we allocate money to cash, or an asset that has the highest liquidity, low return and protection of capital invested. When we worry about a possible market crash and book some profits from our equity shares and invest the money in a fixed maturity plan, we are changing the allocation from growth to income. The first principle to understand therefore is that we all make asset allocation decisions routinely; our wealth manager only needs to help us do it better.

The second principle is that each asset comes with its features and performs differently at different points in time. Growth assets such as land, property, gold, and equity have the potential to deliver high returns over the long term, but may exhibit very high volatility in price in the short term. Income assets such as deposits, bonds, saving schemes, and the Provident Fund may deliver steady returns, but these returns may be subject to default risks or the risk that the rate of return could be modified. Liquid assets may offer the highest level of capital protection, but may deliver a very small rate of return that does not even take care of inflation. Therefore, it is important to stop arguing about which is the best and choose a combination instead. When we speak of asset allocation, we are referring to a considered investment in a combination of assets.

Our wealth managers should be able to state upfront what allocations they are recommending and why. We need to verify their ability to make that decision. The fee we pay them should be in direct proportion to their skills to formulate such an allocation. No one can correctly predict the future course of any asset's return all the time. Some are skilled in managing asset allocations, but most are not. If an advisor is asking us to sell our equity funds and invest in FMPs, we need to ask if he has the skills to take such a call. The financial advisory space is still dominated by compounders and quacks, where qualified doctors with a basic degree are just making an appearance. To imagine that they can perform the complex heart surgery that your portfolio may need is naive. Not all wealth managers are experts in asset allocation. When in doubt, stick to the basics.

Third, most financial products do not offer a simple asset to investors, but pile on various tricks and strategies of implementing an investment in that asset. A property is sold as prime future location; an equity fund is sold as a smart product that will pick tomorrow's winning stocks today; and a debt product is sold as offering a risk-free assurance of return.

Producers need to showcase their skills in managing investments better than their competitors. It is important to see that the range offered is not confused for what it does. The choice of paranthas and dosas in a restaurant do not take away our basic understanding of what it is made of and what its nutritional value is. We need to see this clutter of choices as mere variants, and our wealth manager needs to help us make sensible choices. If we learn to think about our investments as asset allocation decisions, rather than product choices that are likely to give the best return, we have taken the first critical strategic decision about our wealth.

Source: Economic Times