Archive for the ‘Financial Advisor’ category

Who pays your advisor?

July 4, 2008

A Very good Poker joke is “Look around the table. If you are not able to find who is to be had that evening, it is you”. Similarly when you are with a professional and you do not bother to find out how he is compensated, frankly, I do not think it is the advisor’s fault. Learn to ask the correct questions. The title of this post is one such question.

The greatest dividing line that separates financial professionals is fiduciary obligation. By law, a fiduciary must act solely in the best interest of the client. As such, a fiduciary is obligated to reveal any potential conflict, as well as to fully disclose how they are compensated for their services.

Doctors, lawyers, chartered accountants, trustees are fiduciaries. In April 2005, the SEC set forth recent regulations that require brokers and other financial professionals to include the following to indicate an absence of fiduciary obligation:

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interests. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.”

If you see this disclaimer, you should ask questions, request complete disclosures, and really question if this is the establishment that seeks to advance your best interests.

After all, that’s why you hire a financial advisor in the first place, isn’t it?

However, most investors do not spend enough time and effort on training themselves about the questions that they should ask. That is gross neglect. See what even SEC is saying is “advisers will answer questions that are asked”. So if you do not know what to ask, God save you!

How Does Your Advisor Get Paid?


The manner in which your advisor gets compensated speaks directly to the question of whose best interest is being served—yours or theirs. Essentially, there are three distinct compensation models for financial advisors:

Fee-Only Compensation: This model can minimize conflict of interest. A Fee-Only Advisor is paid for advice rendered and for ongoing management. No other compensation can be rendered by any other financial institution, thus advancing the fiduciary standard. Fee-only advisors are paid solely for their knowledge and their asset management services.

Fee-Based Compensation: Frequently confused with Fee-Only Advisors, but not at all the same, fee-based advisors may earn only part of their overall compensation from advisory fees paid by clients. They may also receive compensation for commission-based products they are licensed to sell, advancing an inherent conflict of interest. As such, fee-based advisors do not hold to a fiduciary obligation.

Commissioned Compensation: Commission-compensated advisors can face enormous conflict of interest. A financial benefit can only be derived through transactions, creating a bias toward account activity. Unbiased advice is an improbable outcome for investors who use the services of commissioned advisory services. Further complicating the conflict of interest issue, commissioned representatives can receive incentives for selling one investment over another.

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Choosing the financial adviser..

June 30, 2008

This is arguably the most important financial decision in your life you will ever make! Not too long ago life was simple. You wanted a bank account, you went to a bank. If you wanted to buy shares, you went to a sub-broker (a broker was out of reach till about 15 years back). If you wanted a life insurance, a LIC agent sold you some policy which you hoped was good.

Today you find bankers who actively discourage you from coming to a bank. Insurance agents who sell you anything buy a life insurance product. Bankers who sell you mutual funds, life insurance, broking accounts, and real estate!

And the companies that sell you financial products are dime a dozen – Reliance (Mukesh) has a loyalty card, Reliance (anil) has a credit card. A call from Reliance Money says “Reliance Bank” and offers you a loan! Airtel offers you money transfer, cell phones can be used for paying utility bills. Why do I need a bank, a cheque book, a relationship manager? I do not know!

Now into this mess comes in a financial adviser. He should tell you the difference between information and noise. He should encourage you to write down your goals. He should be able to understand the difference between a 3 month track record of a scheme and a 3 year performance. He should be able to FORCE you to buy life insurance MUCH BEFORE you need it. Your pension plans and medical insurance plans should be in place when you CAN rather than when you must. He should be able to help you prioritise your goals. He should have the guts to tell you that your goals make sense only when you allocate resources for the same.

HOWEVER, he should not sell any products to you EVEN if it is a zero load mutual fund. Because then, he loses credibility. It is like a rep of a pharma company – I cannot trust him like i trust my family doctor. Sorry, I know this is an old world view.

Do you need an investment advisor, at all?

February 16, 2008

Or Why you do not need an investment consultant !

If you need bypass surgery, you should find the most qualified surgeon available. If you’re getting sued, you should hire the best defense lawyer in town.These 2 are fairly obvious and I do not think you can do your own root canal surgery, brain surgery or heart surgery. Come to think of it, it is so inconvenient, is it not!Likewise, some people argue that if you’re planning to live well in retirement, you should hire the most expensive financial advisor you can find.

To me this causes a twitch!

I do sessions on financial planning and these sessions are reasonably well attended. Mostly at the end of the session the participants are unable to decide whether they can do their own financial planning or they need an outsider.And while people ask me questions on everything from momentum investing, auditor integrity, mutual fund loads, broker integrity, insider buying, etc. one question uppermost on people’s mind is

Can I do my own financial planning?

And

Can I do my own investing?

If you’re an investor who is seeking long-term capital gains, it’s crazy to pay a lot of money for a high-priced financial advisor who gives you an economic outlook and short-term market forecast with all sorts of commission-based solutions attached. To the best of my knowledge there are only a few (so few you cannot spot them) pure financial planners.Nor do investors generally need a “personal investment plan” based on their individual circumstances…

There’s Only One Objective for Long-Term Investors

A growth portfolio is designed to keep you from outliving your money. It should give satisfactory returns for a 25-year-old just beginning an investment plan, as well as a 55-year-old who may live three decades or more.

To quote Sir John Templeton, “For all long-term investors, there is only one objective – maximum total return after taxes.”

Of course, some advisors take generic advice and selling it as customized plans. For that reason, whenever I hear an investment advisor tell a client that he is drawing up a long-term growth portfolio based on that client’s “unique profile,” I’m invariably reminded of the Head of HR who tells his audience, “Never forget that you’re special… just like everyone else.

But, as is fondly said, “It’s 97% of investment advisors that give the other 3% of us a bad name.”

In the Indian context the commission structure is too badly designed – it is a design fault rather than a sales fault. But there is no body who really wishes to complain. After all in a bull run the manufacturer (called Mutual funds, Life insurance companies, PMS providers) need sales guys who go and get them money from the “client” for these guys to manage.So if it is a 70% upfront commission in a unit linked plan or the 6% asset management charges or the 2.4% amc in a debt fund, well there is no one to protest!

So you may need a financial planner (whose functions are so comprehensive) that I shudder to think why would somebody want to be a financial planner on a just fee basis.

Frankly if you wish to create wealth in the long term put your money in the cheapest index fund, buy the cheapest term life insurance, and go fishing.

Leave your mobile, TV, broker…in the city and play with nature. You will return fresher and richer.

Common financial problems

February 12, 2008

In all my financial interactions – be it planning for clients, training, teaching or writing, people have come to me with some problem which they think is unique. In all the financial problems, I am able to find a pattern. Believe it or nor, people more often than not choose the problem by their behavior. It is easy for me to find a pattern and say, “Well you chose your problem, did you not?”

Your financial problems would have been caused by some (or all) the following financial behavior:

~ Not planning: The single biggest problem for most people is that they just do not plan their finances. Even if they are not happy about the results of what they have done so far, they do not change the way things are done.

~ Overspending: Many people with not very high incomes have very high ambitions. Most of this problem is because the salesmen in most shops do not tell you the price of a product, they only tell you the EMI — so anything from a plasma TV to a luxury home on the outskirts of the city are made to look cheap! After all at Rs 2,899 a month does a plasma TV not look cheap?

~ Not talking finance at home: Children are kept away from the finance topics at the dining table. Finance is perhaps the second most taboo topic at home! So many children grow up without knowing how much of sacrifice their parents have gone through to educate them.

~ Parents spending on education and marriage: There are just too many kids out there who believe that they need to worry about savings, investment and life insurance only at the age of 32 plus. This means your father, father-in-law or a bank loan has funded your education and marriage. Kids should take on financial responsibility at a much younger age than what is happening currently.

~ Marriage between financially incompatible people: Most marriages under stress are actually under financial stress. Either the husband or the wife is from a rich background and the other partner cannot understand or cope with the spending pattern. It is necessary to match people financially before marriage.

www.akshayapatra.org

~ Delaying saving for retirement: “I am only 27 years old why should I think of retirement” seems to be a very valid refrain for many 32 year olds! Every year that you delay in investing the greater the amount that you will have to save later in your life. Till the age of 32 it might be feasible for you to catch up, but after some time the amount that you need to save for retirement just flies away.www.myirisplus.com

~ Very little life insurance: With all the risks of life styles, travel, etc. illness and premature death are common. We all have classmates who had heart attack at the age of 32 but still pretend that we do not need life or medical insurance.

~ Not prepared for medical emergencies: Normally big emergencies — financially speaking — are medical emergencies. Being unprepared for them — by not having an emergency fund is quite common.

~ Lack of asset allocation: Risk is not a new concept. However, it is a difficult concept to understand. At 3k index people were afraid of the market. Now everybody and his aunt wants to be in the equity market — and there are enough advisors who keep saying, “Equity returns are superior to debt returns.” This is true with a rider — in the long run. So there could be a much larger allocation to equity at higher prices — to make for the time missed out earlier.?

~ Falling prey to financial pitches: The quality of pitches has improved! Aggressive young kids are recruited by brokerage houses, banks, mutual funds, life insurance companies, etc. and all these kids are selling mutual funds, life insurance, portfolio management schemes, structured products, et al.

~ Buying financial products from ‘obligated persons’: This is perhaps one of the worst things you can do in your financial life. A friend, relative, neighbor, colleague who has been doing something else suddenly becomes a financial guru because they have become an agent! You are saddled with a dud product for life!

~ Financial illiteracy: Most people do not wish to know or learn about financial products. They simply ask, “Where do I have to sign” — so buying a mutual fund is easier than buying life insurance!

~ Ignoring small numbers for too long: What difference will it make if I save Rs 1,000 a month? Well over a long period it could make you a millionaire! So start early and invest wisely. It will make you rich. That is the power of compounding.

~ Urgent vs important: Most expenses, which look urgent, are perhaps not so important — the shirt or shoe at a sale. That luxury item which was being offered at 30 per cent discount is such an example. These small leakages are all reducing the amount of money you will have for the bigger things like education or retirement.

~ Focusing too much on money: Money is no longer a commodity to buy things. It is a scorecard of one’s life. That will cause stress, and yoga might help. However if you will seek a branded yoga teacher — so that your friends think you have arrived, yoga it self could cause financial stress!

Good life insurance starts with a good life insurance agent

January 31, 2008

The key to quality insurance is in choosing a good quality Agent.  The word agent comes from the Indian Contract Act, 1872 and it is the Christian name for the guy who brings insurance / mutual fund product to your door step. Nowadays they have various names like Consultant, advisor, and the like, but I will use the word in its real meaning!

Very many people do not think it is really material as to whether you select a good quality agent or a friendly neighborhood agent. Risk cover and wealth management are both things that you need to plan for much, much in advance before the event. Imagine thinking you have cover for medical emergencies….but realizing that it is not renewed AFTER you have had an accident. Imagine getting up on your 55th birthday and realizing your retirement target amount is 15 years away. It will be too late to react. So choose an agent carefully. He / she can make your sunset years golden or red!  Lets’ look at reasons for NOT selecting a person as an agent:

1.      He is a neighbor. This can mean he is available for you, not that he is best. Typically if he has meandered in his career and at last (?) decided that selling insurance or mutual fund is his calling that may not be sufficient.

2.      The brother-in-law, sister-in-law, father-in-law syndrome. Same as above. If they have built a business over a long period of time that is a good basis for selection. Not otherwise.

3.      length of being in the business – normally this is an excellent reason to buy from a person. However in some cases it might mean that these are not enough reasons. Check if he / she is unbiased. Normally such people get stuck to one company and so many years brainwashing has lulled them into believing all good things happen only in that company and other companies are bad. For e.g. in India you will find enough insurance agents saying “private companies may not pay the claim”. This is hogwash. All private companies are reputed and have come with very, very strong partners. Lets not kid ourselves. They will all pay. In case they decide to leave India, they will sell their portfolio to an Indian company and then leave. Look at Sanmar.

4.      Its’ the bosses’ wife: I have absolutely no excuses to offer! Play it by the ear, or get your CV ready!

5.      It is a customer’s wife: keep the premium to the diwali gift level!

6.      Its your bank: They know the exact amount of money in the bank, they know where you eat, how you travel, what school your kids go to, which credit card you have, but if they cannot plan your finances, be careful.

7.      The guy who does not talk about term insurance at all. It is not to say that TERM insurance is the best, or it is most suitable, but he should offer it to you. He should tell you that there is something called top up in an unit linked plan. He should tell you about single premium products. You choose the end product. He should give you the choice.

8.      The agent / bank / advisor who sold you a plan which somebody knowledgeable called a lemon! If you have been had once, that is enough. Do not repeat it.  

Having said what CANNOT be the reasons NOT to buy from a set of people, lets look at what you can do to protect / save yourself from trouble:

1. Ask to see the agent’s insurance (IRDA) / mutual fund (AMFI) license. You actually want to be treated by a doctor, not the doctor’s husband, wife, daughter, father…..A license is personal not transferable. See it check for validity. It is yours by right.

2. Ask how many companies the agent represents– if an agent represents a number of mutual funds / insurance companies, he has the ability to look for the best policy to fit your unique needs and to find the best value for your money. PLEASE note in Indian conditions the agency system is some kind of a irrelevant condition. In one house you will find agents for 4 companies. An agent is supposed to be tied a broker is free to choose any solution for you.

3. How long has the agent been in business? How long has the agent been associated with the agency? Check the length of the association. Longer need not be better. It is only an indicator that the agent will not leave it for another business.

4. Has the agent earned any designations signifying that she has received advanced training in the business of insurance / wealth management..

5. Did you learn about this agent from someone you trust and respect?

7. What are the other things he does along with this business? In Indian conditions there are very, very few people who make a full time income by selling only insurance. If he is also selling other wealth products, that may be acceptable. However if he is a PCO owner, real estate agent, or such other businesses you might need to ask yourself “Why is he an agent”.

8. Who will handle your account on a daily basis? If it is not the agent, ask to meet the other person. Ask about his background, length of service with the agency, etc.

9. Ask how the agent perceives his role in handling claims. In case of general insurance you will live to learn! In case of life insurance you cannot even ask him for a reference! Telling him your ghost will haunt him may not be enough.

11. Ask him his educational qualifications. There is nothing to say that a qualified person is more up to date than a person who is not qualified, but it might help. CFA, CFP, CA, CWA, ACS, are all selling life insurance and mutual funds. It is an alphabet soup out there! No single qualification really means that the person understands all your financial needs. Equip yourself with knowledge. That is the real protection.

12. Is the agent a member of any local / national body of professionals which is subject to some code of conduct?

13. Has any action been taken against him in any forum? Does he have any commendation given to him by say, a neutral body?

14. If he criticizes the competition, beware of him. It may be sheer lack of knowledge. Ask him to say good things about the competition. That is a great test at being balanced. Believe me, its tough!

15. Ask him whether the money that he earns from the product that he sells is significant part of his earnings. If it is not, he is likely to give it up.

16. Make sure he understands risk cover, asset allocation, risk profiling, switching between funds, and equip yourself enough to ask all these questions.

Start with a prayer that always helps!

   

Financial Planner – do you need one at all?

January 14, 2008

Uma Kannan is a good friend and an ex- blue blooded MNC banker. Here she is taking potshots at her own ilk. She says when she was with the bank, she was a “rogue deal seeker” but she felt good in calling herself a relationship manager, investment adviser, associate director…and various other nice names which HR faithfully found her!

A small investor should never invest on her/his own. S/he should choose a mutual fund. But is it easy to

choose a mutual fund? Heck no. S/he needs a financial planner to tell her/him whether s/he should

put money in a mutual fund, a structured product, a unit linked plan, a classic endowment plan,

a pension plan, real estate, or what have you.

And what will a financial planner do for you? S/he will structure your portfolio, s/he will suggest that you file your income tax return through a particular CA, ask you to invest in a particular mutual fund, buy a particular insurance, suggest that you make a will, check your nominations etc.

Then you go to a CA to file your return, a bank to make your deposits, a mutual fund agent to buy you mutual funds, a life insurance agent to buy life insurance, a lawyer to make your will and the story goes on.

Ha ha, now how many ‘professionals’ do you deal with? Here’s a small list. You ca add your own to this at leisure.

Professional

Her/his fees per annum
A financial planner Rs 25,000
A CA to file your IT returns Rs 10,000 (assuming 2-3 returns in a year)
A mutual fund cost approximately 3 per cent as asset management charges
A life insurance company cost same as a mutual fund in the long run
A portfolio manager for your shares 4 per cent charges
A broker + banker 2.5 per cent charges

To keep all of them happy you need a portfolio in excess of at least Rs 1 crore to start with! And all these guys (or gals) smart, sophisticated, nicely attired and perfumed cannot stand each other. So you need to find them all on your own.

Let us say you do have a handsome amount of Rs 3 crores and you employ the above orchestra to play for you. Let us see how much it will cost you.

Also, let us assume that this orchestra helps you earn 13 per cent return on your Rs 3-crore investments, which amounts to Rs 39 lakhs per annum. Then this is how your expense cookie will crumble:

Expenses

Financial planner        Rs 25,000
CA Rs 10,000
Mutual fund Rs 90,000
Insurance premium Rs 90,000
Portfolio Manager Rs 1,17,000
Banker Rs 1,00,000
Total costs Rs 4,32,000

At a portfolio of Rs 3 crores this amounts to ALMOST 10 per cent of the return that you received. After all this, they will tell you the following:

“We are paid on efforts basis; we cannot guarantee results. Mutual funds are subject to market risks”

Past performance is not a guarantee of future performance — or like Sehwag should we say “past non-performance is not a guarantee of future non-performance”?

Interestingly, if instead of this whole orchestra you were to put your money in PPF, a long-term bond fund and an indexed fund and earn a little less than 13 per cent per annum, you may still be better off.

But, I do have a financial planner who says that I need the fellow professionals to help me. What do I do?

Well, er, if your financial planner was selling car loans, home loans, mutual funds, life insurance and s/he has suddenly turned from a larva to a butterfly, well s/he still wears some of those hats. So surely out of the 10 per cent charges that this client is paying some of the money goes back to her/him.

Let’s look at this conversation between the client and his financial planner:

Client: Hi I heard you are a financial planner, can you plan my finances?

Planner: Yes of course, I can and will.

Client: Will you promise returns superior to the market?

Planner: Oh no! I can help you set your financial goals, risk profiling, finding you a lawyer who will make a will for you, a CA who will file your returns etc. But for selecting which mutual fund to invest and such other questions you should be asking a Portfolio Manager.

Client: And how much will you charge me for this service of yours?

Planner: Well I charge Rs 25,000 or 1 per cent of your assets whichever is higher.

Client: Thank you. Now I will meet the portfolio manager.

Client: Hello, Mr P M, will you manage my portfolio please? Of course, I know you will but what I want to know is how much will you charge me for doing this?

PM: Of course I will, and I will charge you about 3-4 per cent of the assets under management.

Client: Well, that’s too high but will you promise me a return greater than the average return in the market for the fees that you charge?

PM: Well I will actually decide on how much money to keep in debt instruments, how much in cash and how much in equities. I hope your financial planner has taken care of your life insurance. By the way, you will be glad to know that I am also a life insurance agent.

Client: Oh yes. My planner has asked me to buy a very low up front charge based unit linked life insurance plan.

PM: Oh this life insurance? Their initial charges are low, but their asset management charges are quite steep. Why did you choose this plan?

Client: I thought my planner was keeping my interest in mind.

PM: Of course, of course s/he must have thought of you. By the way I think you should invest 30 per cent in RBI bonds, 20 per cent in a unit linked pension plan which is equity based, 30 per cent in a classic endowment plan, and keep about 20 per cent in cash.

Client: In which mutual fund do you think I should invest?

PM: Here are some mutual funds with an excellent track record for the past 3 years — they all have given about 45 per cent return and I think they will do well in the next few years.

(After a few days)

Client: Mr Planner out of the money that I gave you for life insurance only 70 percent has been invested? Why?

FP: Sir I did tell you that it is low front end loaded unit linked life insurance�.

Client: But 30 per cent charge on such an insurance plan cannot be low, can it be?

FP: Of course it is low. There are some schemes which have 70 per cent load, comparatively this is low; is it not?

Client: Oh I see. And the endowment plan which the PM recommended to me. In that case I do not know how much the charges are. Correct?

FP: Yes, Sir.

Client: the mutual fund has also charged me about 2 per cent. That is very low is it not? Is it not lower than the 3 per cent that you told me?

FP: Yes sir. However, I have to tell you upfront — in keeping with the best practices — annually the mutual fund is allowed to take 2.5 per cent charges. You see they have to pay the trustees, the fund management company, the distributor’s trail, the audit fees, custodian, the registrar and transfer agent, the bank, etc.

Client: Oh I see. I hope these are the only charges that are levied.

FP: Yes of course, but for some small brokerage that actually gets added to the cost of the shares and is hidden from you by the mutual fund.  

Client: But I am happy to see that my RBI bonds got invested fully.

By the way it is nice to see that my planner, my portfolio manager, my broker, the trustee, the auditor, my CA who files my return, my lawyer who makes my will, the custodian, the asset management company, the distributor, the auditor of the schemes, the registrar and the banker will all make money. I really feel good.

By the way, will I make money�er, do I have guarantees?

FP: In this whole investment cycle which you saw, did I ever tell you to do any work?

Madam/Sir it is a very fair world — those who work hard make money.

The client goes away — to watch television which will tell her/him how easy it is for the common man to make money using futures and options. But then that is another story all together.

Innumeracy means you are weak in Mathematics

January 11, 2008

Innumeracy – a lack of understanding of mathematics. It keeps happening in the media all the time. Many writers and broadcasters do not understand the difference between “what cannot happen” and “what has not happened”. Yesterday Mr. Anil Ambani was saying that he has 100 million customers – i.e. about 10% of India’s population who use his services – mutual fund, life insurance, electricity, telephone etc.

Is this correct?

Well what about the double counting that has happened? What about the reliance subscriber who has a reliance mutual fund, life insurance and has reliance electricity connection at home? Well reliance power will enlighten us, I presume!