Whose Word Can You Trust?

Recently I came across a video of a highly respected fund manager in which he offered personal finance advice to investors in general.  One of the things he spoke about was asset allocation.  On checking around, I gathered that a number of people had found what he had said to be worthwhile.  It wasn’t clear as to how widely the video had been watched online, but on one portal there were five times more ‘likes’ than ‘dislikes.’  Here’s the problem: the fund manager’s views on asset allocation were flawed and misleading.

There is a certain personal finance blog that is written by a gentleman who apparently has no professional experience as a financial advisor.  To be fair, he is better versed in matters of personal finance than an average investor.  But that’s probably the best that I can say of him.  I have read posts in which he has distorted facts, made false claims, and expressed views that are flawed and downright ridiculous.  Despite all of this, his is one of the most popular personal finance blogs in India and a number of readers appear to blindly trust anything that he has to say.

These are not isolated instances.  There are countless personal finance blogs written by people who have no grounding or experience in that subject.  And I frequently come across experts waxing eloquent beyond their ken.  Sadly, far too many of us are falling for the questionable advice being dished out by these individuals.

So how can we distinguish an expert from a non-expert?  How can we know when to trust an expert?

The plain truth is that there is no foolproof way.  If you think about it, only an expert can truly know if someone else is also an expert.  The rest of us have to make a presumption about an individual being an expert.  At best, we may have, what some call, a justified belief of a person’s expertise.  I give below some thoughts on how we might build such a belief.

Understand the area of expertise: Thanks to the business channels on television, for a number of us, there is an enduring image of an “investment expert”:  someone who can explain why the stock markets moved the way they did on a given day, predict how they are likely to perform in the next few days, and advise on the suitability of buying or selling a given stock.  This is a highly dubious stereotype.  For one, it is debatable as to whether short term forecasting can be an area of expertise.  For another, there is a lot more to investing than just analyzing stocks.  In fact, the landscape of investing is too vast for anyone to be an expert across all its aspects.  Fund managers and analysts, while competent in matters of researching securities and analyzing the macro environment, are hardly qualified to advise on matters of personal finance.  Financial planners and mutual fund advisors, while better placed to advise their clients on asset allocation and selection of mutual fund schemes, are rarely equipped to analyze stocks.  Knowing an expert’s area of expertise helps in noticing when he/she strays from it.

Look for indicators of expertise: To some extent, one’s academic credentials and certifications can be an indicator of his/ her expertise.  Personally, I regard professional experience and testimonials from known or proven experts as better indicators.  But more than that, I look for clues in what a person is saying.  Are there any factual inaccuracies?  Is there a clear logic in what is being said?  Are all points consistent with each other? 

Watch out for conflict of interest: Good intentions are by no means a substitute for expertise but questionable motives can dent the credibility of an expert.  A number of fund houses are known to insert subtle (and not-so-subtle) promotional messages in their so-called investor education programs.  And there are a number of bloggers who focus more on their ad revenues and search engine rankings rather than the quality of their content.

Listen to your instincts: Each one of us has an in-built warning system.  Mine makes me uncomfortable with individuals who trumpet their credentials.  I am also wary of those who make assertions without sufficient evidence.  And I tread particularly cautiously when such assertions are made with a high degree of confidence.

Ask Questions:  If still in doubt, do ask questions.  For more on this, check out this post.

In case you’d like to dig deeper, check out this piece that summarizes and expands upon some of the best research on the subject of assessing expertise and trusting experts.

The Importance Of Asking Questions

When it comes to unravelling any complex concept, it is said that there is no better way to do so than by asking questions.  I would go further and say that to navigate the complexity of investments and markets, our ability to ask questions is an essential survival tool.  Over the years, as an investment advisor and an observer of the mutual fund industry, I have come to see this ability as a key differentiator between those who have truly benefitted from investing in mutual funds and those who have not.

Indeed, the edifice of my own learning has been built on this foundation.  Soon after I got started in this business, we had one of the most spectacular bull runs that the Indian markets have ever seen.  Seeing the BSE Sensex soar by around 300% between Jan 1991 and April 1992 made investing in equities seem like a cakewalk.  It also made it easy to be blind to the inevitable, brutal downslide.  Despite the existence of stock markets for over a century, there were no handbooks, manuals or courses of any consequence which could guide inexperienced investors or wannabe advisors.

Those were early days for mutual funds.  The lack of good regulatory understanding allowed for schemes to assure returns despite market risk.  It allowed for closed-end equity schemes to be freely peddled by thousands of agents who had no experience or understanding of the risks associated with these products.  All put together, it set the stage for hundreds of thousands of investors, who had no temperament for the uncertainty of equity markets, to trade the safety of fixed deposits for these products.  It was the perfect recipe for disaster.  My knack of asking questions is the primary trait that I can credit with guiding me and eventually, my clients, through this minefield.

If the intent is to clarify doubt, then there is no such thing as a ‘silly question.’  Any question, every question, in its own way, can help.  As an investor and an advisor, I never hesitated to ask questions, no matter how much of a fool I risked appearing.    For instance, I would ask fund managers about what gave them the confidence that they would be able to deliver returns that are better than a fixed deposit. Or, how certain were they that when they decided to sell some of the stocks that they held, there would be someone willing to buy those stocks.  Or, in a closed end scheme, if there are far too many investors, could one reasonably hope to find buyers if one wanted to sell one’s units before maturity?

Not every question would get clear or even adequate answers.  But, altogether, they were enough to clear the haze and lay bare the nature of risk.  In fact, I would stick my neck out and suggest that for any investor there can be no more important thing to learn than the nature of risk, and that there is no better way to do so than by asking questions.  In my opinion, it is too complicated a subject for any amount of educational material to do justice to it.

In the US, the Securities and Exchange Commission has a publication titled, Ask Questions.  It lists questions that investors should ask about investment products, the people who sell these products, and even about the progress of one’s investments.  It starts with this advice:

“Ask Questions.  That’s the best advice we can give you about how to invest wisely. We see too many investors who might
have avoided trouble and losses if they had asked basic questions from the start.”

Though it is meant for American investors, in the absence of anything similar in India, I would strongly urge investors to check it out.

I would like to close this post with the remarks of a US investment regulator who probably did more than anyone I can think of, to protect and educate investors.  In one of his many, memorable speeches, Arthur Levitt said:

“As an investor, you certainly have the right to be treated fairly, to get straight answers to straight questions, to know what you are buying and what you are paying for it. But as an investor, you also have an obligation to ask questions – many questions – to seek out information, and contemplate your own tolerance for risk.”  

He closed that speech with these invaluable words:

“Say yes to informed, careful, realistic, skeptical and long-term investing.”