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.

Where Mutual Funds Add Value

This is not a post based on my thoughts.  It reflects those of Colaco & Aranha, a Mangalore-based financial advisory firm.  It is a firm that I greatly admire and respect.  For quite some time now, I have considered giving readers of this blog a slice of their wisdom: something that I have personally benefitted from.  As the firm completed 30 years in business this week, it struck me as a good opportunity to do so.

In particular, I would like to share a video of a presentation by Mr. Gerard Colaco, partner at the firm, about the areas where he sees mutual funds adding value.  But before stepping into the video, it may help to have a quick look at some of the firm’s beliefs (a few of which come up in the presentation as well):

• Never expect an investment adviser to take a greater interest in your money then you yourself have a duty to take.
• The ideal client-adviser relationship is one of partnership, not dependency. An investment adviser must make investor education an essential part of his practice. The better informed, interested and participative the client, the better will the expertise of the adviser be exploited.
• All investment must form part of a plan. It is never too late to plan. Having a plan without the money to invest is better than having money to invest without a plan.
• Investment principles are universal but investment plans are unique, because each individual is unique with unique circumstances, needs and temperament.
• Financial responsibility is far more important than financial literacy, just as common sense is far more important than cleverness.

This, then, is the link to the presentation.  It has a running time of about 2 hours.  This presentation was made a few years ago.  Since then, there have been regulatory changes, and changes in tax laws, but most of what is said continues to remain very relevant.  This video is courtesy of Simplus Financial Consultancy Private Limited, an associate of Colaco & Aranha.

Fund Volatility and SIP Returns

A few readers of my previous post have said that I was wrong in suggesting that all funds are equally suitable for a SIP.  According to them, if an investor who is proposing to start a SIP, had to choose between two funds, he/she would be better off choosing the fund that is likely to be more volatile (i.e. the fund that is likely to see greater fluctuations in its NAV). 

This is not the first time that I have heard this argument.  Over the years, I have heard many advisors voice a similar view.  Unfortunately, this is a flawed perspective that is, paradoxically, the result of intelligent thinking.  In this post, I propose to clear the air on this.  But since this may not be easy to explain or even follow, let me first cut to the chase, and state my position:

a.       There is no conclusive or compelling evidence that supports this argument.

b.      Pursuing such a strategy can potentially have disastrous consequences if one is forced to redeem one’s investment in a bear phase.

If you’d like some elaboration on this, do read on.

Let me start by questioning the mathematical validity of the volatility argument, if I may call it that.  Imagine, if you can, two equity funds that, over a certain period, start with an identical NAV, and end with an identical NAV.  Let’s further assume that, over this period, these funds have an identical average NAV.  This may be a hypothetical scenario but it is one that immensely favors the volatility argument.  If the argument truly has merit, then in such a scenario, an investor opting for a SIP in both funds, should always gain more in the more volatile of the two funds.  Yet the fact is that even in such a favorable scenario, there is no certainty that that will happen.

For those who prefer empirical evidence, I’d like to present some data on three of the oldest equity schemes in the country.  The table below gives the data for the period from April 2012 through March 2015.  All the data has been taken from the fund factsheets.

Apr 2012 - Mar 2015	Fund A	Fund B	Fund C
Standard Deviation*	14.2	16.5	15.8
Fund Return (p.a.)	18.6%	17.1%	34.9%
SIP Return (p.a.)	24.9%	25.2%	35.2%

*Standard Deviation (SD) is a measure of volatility. The higher the SD, the more volatile a fund.

Over this period, Fund B was more volatile than Fund A, and despite its lower return, an investor opting for a SIP would have gained more in this fund than in Fund A.  One may say that this data supports the volatility argument.  However, when we compare Fund B with Fund C, the picture appears to be somewhat different.  Fund B was also more volatile than Fund C but an investor opting for a SIP would have gained less in this fund than in Fund C.  One may think that this was because of the much higher return of Fund C over the period.  But before drawing any conclusions, let’s look at the data for the preceding 3 year period.

Apr 2009 - Mar 2012	Fund A	Fund B	Fund C
Standard Deviation	22.5	27.9	28.3
Fund Return (p.a.)	27.9%	26.7%	34.6%
SIP Return (p.a.)	8.8%	4.5%	9.3%

 

This period was marked by a significantly higher level of volatility across all funds.  Yet when you look at Funds A & B, despite a much higher return over this period (compared to Apr 2012 – Mar 2015), an investor who opted for a SIP in these funds over this period would have gained much less than a similar investor in these funds over the subsequent 3 year period.  Fund C had almost the same return across both periods but here, too, an investor who opted for a SIP over this period would have gained much less than a similar investor in this fund over the subsequent 3 year period.  Clearly, the volatility argument does not hold good.

You may also note that during this period, Fund C was more volatile than Fund B.  However, in the subsequent period, Fund B was more volatile than Fund C.  Thus, even if volatility were to matter, to whatever extent, historical volatility of a fund (absolute or relative) can be no indicator of future volatility.  Just to be clear, the investment objectives of these funds did not change over these years.  In fact, these are among the most consistently well-managed funds in the industry.

Let me now flip back another three years to a period that highlights some of the risks of investing in highly volatile funds.

Apr 2006 - Mar 2009	Fund A	Fund B	Fund C
Standard Deviation	28.4	31.5	33.2
Fund Return (% p.a.)	-3.1%	-2.7%	-17.5%
SIP Return (% p.a.)	-13.9%	-13.7%	-30.2%

To put these numbers into context, the value of a SIP over this period in Fund A or Fund B would have been almost 20% below the amount invested, by the end of the period.  The value of a similar SIP in Fund C would have been almost 40% below the amount invested.  So much for the volatility argument.

SIP Returns

A number of investment portals offer tools that enable one to calculate the so-called ‘SIP returns’ of mutual fund schemes.  Most fund houses also offer similar calculators for their schemes.  Some offer these calculations in their monthly fact sheets.  But does looking at the SIP return of a fund serve any purpose?  In this post, I will attempt to show that SIP returns are of little use, and that one is better off not using these returns to draw any conclusions.  To keep things simple, I will restrict my thoughts to SIP returns of equity funds.

The SIP return of a fund is not a representation of its performance. It only tells us the return that an investor would have got if he/she had opted for an SIP in that fund, over a particular period.  The SIP return from investing in a fund can be, and indeed often is, very different from the fund’s actual return over the same period.  As an illustration of this, I have given below some data of two of the oldest diversified equity funds in India. (PS: All the SIP calculations in this post assume equal monthly investments made on the first business day of each month from the starting month till the penultimate month.  Loads are not considered in any of the calculations.)

	Fund A	Fund B
NAV- 01 July 2004	70.67	47.73
NAV- 02 July 2007	228.91	142.70
Absolute Fund Return	223.9%	199.0%
Absolute SIP Return	65.4%	75.9%
Fund Return (p.a.)	47.9%	44.0%
SIP Return (p.a.)	35.5%	40.3%

Over the 3 year period mentioned above, investors in both funds who opted for a SIP saw a lesser return than those who put a similar amount at one go, at the start.  You may also notice that while Fund A gave a higher return than Fund B, investors who opted for a SIP in that fund saw a lesser return than those who opted for a SIP in Fund B.

If we now look at the 3 year period that immediately followed, a pretty different picture emerges.

	Fund A	Fund B
NAV- 02 July 2007	228.91	142.70
NAV- 01 July 2010	263.45	195.03
Absolute Fund Return	15.1%	36.7%
Absolute SIP Return	41.7%	35.1%
Fund Return (p.a.)	4.8%	11.0%
SIP Return (p.a.)	24.0%	20.6%

Investors in Fund A who opted for a SIP over this period, saw a better return than those who put a similar amount at one go, at the start.  Investors who opted for a SIP in Fund B saw a lesser return, in absolute terms, than those who made a lump sum investment, at the start.  However, if you consider the time value of money, as reflected in the annualized returns, the SIP investors benefitted more.  In contrast to the previous 3 years, over this period, Fund B gave a higher return than Fund A, but investors who opted for a SIP in that fund saw a lesser return than those who opted for a SIP in Fund A. 

In the examples above, both the fund returns and the SIP returns were positive.  Yet, it is possible for one or both of these to be negative.  The data below, of another diversified equity fund, illustrates the possibility of a fund’s return being negative, and SIP return being positive.

NAV- 01 Jan 2008	40.71
NAV- 01 Jan 2013	33.49
Absolute Fund Return	-17.7%
Absolute SIP Return	24.9%
Fund Return (p.a.)	-3.8%
SIP Return (p.a.)	8.8%

There is also the possibility of a fund’s return being positive, and SIP return being negative, as the data below, of yet another diversified equity fund, shows.

NAV- 01 Dec 2003	29.86
NAV- 02 Mar 2009	51.98
Absolute Fund Return	74.1%
Absolute SIP Return	-2.3%
Fund Return (p.a.)	11.1%
SIP Return (p.a.)	-0.9%

So, what explains these numbers?

While a fund’s return does influence the SIP return, the extent of that influence depends on the pattern of NAV movements over the period.  Odd as it may sound, some patterns cause the SIP return to exceed the fund’s return, while others bring down the SIP return to below the fund’s return.  But knowing the effect that a particular pattern has, doesn’t really help because neither can a fund manager control the pattern of NAV movements for a fund, nor is it possible to predict the future pattern for any fund.

In this backdrop, consider this: even if we believe that a more competent fund manager is likely to generate better fund returns than a less competent one, the pattern of NAV movements may make it possible for a SIP in a poorly performing fund to give a better return than a SIP in a well performing fund.  The only thing resembling any kind of certainty is that the longer we carry on a SIP, the more likely it is for the SIP return to mirror the fund’s return. 

Yet, every now and then I come across supposed advisors who wax eloquent about how some funds are “more suitable for a SIP.” At the start of each year, and occasionally in-between, I also see recommendations pop up for “the best funds for SIPs.”  To anyone who understands the maths of SIP returns, these are flawed notions which consciously or not, capitalize on the misconceptions of investors.  But all of these pale in comparison to a remark that was brought to my attention, that The Economic Times attributed to the CEO of a fund house: “our CIO-equity runs… …the number 1 fund in the country in 10-year SIP (systematic investment plan) returns.”  The statement may be factually correct, but to me, the mention of SIP returns in that sentence is nothing short of deception.

As I see it, SIP returns serve little purpose and are best ignored.

Know Your Enemies

The road to investing success can be likened to a battlefield.  There are people and entities out there, who want a share of our money, and may stop at nothing to get that.  There are also other obstacles that, if not overcome, can harm our aspirations, and even leave us financially crippled.  These people and obstacles are the enemies that I allude to.  What makes things tough is that some of these people give the impression of being friends, not foes, and that some of the obstacles are simply hidden from plain sight. This post is intended to put a spotlight on a few of these enemies.

Taxes and Inflation

There is a quote of unclear origin that goes thus: “The way to crush the bourgeoisie is to grind them down between the millstones of taxation and inflation.”  The author may as well been talking about investors.  Consider this: if the rate of inflation were to be 8%, for someone paying 30% as taxes, to merely break-even against the combined impact of taxes and inflation, he/she would have to earn a return of 11.43% p.a. on his/her investments.  To see any growth in the true value of his/her money, such an investor would have to earn a return greater than that.

Of the two, inflation is the bigger threat.  It is inescapable, and carries a greater impact.  For example, on an investment return of 9% p.a. over a period of 10 years, having to deal with an inflation rate of 8% p.a. is equivalent to paying taxes each year at the rate of almost 90%. Inflation is also more stealthy: taxes are mostly visible as we pay them, year after year, whereas inflation creeps up on us from behind and eats into our purchasing power. 

Equity funds can help fight inflation.  These are also highly tax-efficient.  Opting for debt funds over bank deposits (or most other debt instruments) can bring down one’s taxes, provided one is willing to hold these for over 3 years.  Amongst debt funds, open-end schemes carry one significant advantage over closed-end schemes: one can defer one’s taxes as long as one wants to.  Obviously, selecting the right equity and debt funds is important. Knowing how much of each to have in one’s portfolio (i.e. the asset allocation) is crucial.

The Financial Services Industry

In his investment classic, ‘The Four Pillars of Investing,’ William Bernstein had this to say about the financial services industry:

“Investors tend to be touchingly naïve about stockbrokers and mutual fund companies: brokers are not your friends, and the interests of the fund companies are highly divergent from yours. You are in fact locked in a financial life-and-death struggle with the investment industry; losing that battle puts you at increased risk of running short of assets far sooner than you’d like. The more you know about the industry’s priorities and how it operates, the more likely it is that you will be able to thwart it.”

In the introduction to this blog I referred to the noble purpose that the mutual fund industry serves.  Yet, as I have pointed out (for instance, here), many, if not most, fund houses have indulged in dubious practices.  Worse, there has been a tacit collusion between some unscrupulous fund houses and their distributors to legally make money off investors in a manner that raises questions of ethics and morality. 

Just to be clear, their intentions of ill-will should not make us stay away from investing in mutual fund schemes.  The reasons for investing remain as compelling as ever.  It is important that while doing so, we be aware of this and take adequate precautions to protect our interests.  Gathering information and perspectives is a vital part of being prepared to deal with these enemies.  As you do so, be sure to distinguish facts from opinions.  Verify facts, if necessary.  Question the opinions till you feel satisfied.  In addition, as I suggested in this post, ask questions of those whom you engage with: advisors, representatives of fund houses, or anyone else.  Trust only those whose integrity you feel comfortable about, and whose competence you see little basis to doubt.

The Person in the Mirror

Yes, you read that right.  According to Benjamin Graham, regarded by many as one of the greatest minds in investing, “the investor’s chief problem—and even his worst enemy—is likely to be himself.”  In case this makes you wonder, there is a large body of evidence that illustrates that most of us make flawed investment decisions.  Research also shows that our natural behavior leads most of us to be poor investors.   To put it in the quaint prose of William Bernstein: “Most of what we fondly call ‘human nature’ becomes a deadly quicksand of maladaptive behavior when allowed to roam free in the investment arena.” 

Our awareness of this fact, while an important step, still leaves us with significant challenges.  If we are fortunate to have access to the services of a good financial advisor whom we can trust, then we may have far less to worry about. Good financial advisors not only steer their clients clear of the pitfalls of their flaws, they also act as a behavioral coach.  Of course, good financial advisors are few and far between.

For most of us who don’t have access to a good financial advisor, it will be an uphill task correcting our flaws on our own.  A good starting point would be to acquire knowledge about the nature of these flaws.  There is one resource, in particular, that I would like to recommend in this regard.  This is a series of videos that were aired on the program, ‘Nightly Business Report’ on PBS in the US over 2009-10, under the title: ‘Your Mind and Your Money.’  Most, if not all, of the episodes have been uploaded on YouTube, and can be accessed by searching on the PBS channel.

To sum up, the enemies listed here may not be adversaries in any traditional sense but we would do well to treat them as such.  To quote Gerald Loeb in his book, ‘The Battle for Investment Survival’: “Your best weapons against the forces that tend to clip your fortune are knowledge and experience.”

Remembering the Tech Boom

This month, fifteen years ago, signalled the end of the bull run that has come to be referred to as the dot-com boom or the tech boom by some, and the dot-com bubble or the tech bubble by others.  As the monikers suggest, it was a period that was marked by the steep and questionable rise in the share prices of technology companies.  As I see it, what happened during that phase, and what followed afterwards, has a lot to offer current investors in equity schemes to think about.  In this post, I propose to take a walk down memory lane, and share some observations.

A number of people trace the start of this boom to December 1996.  But it was two years later that the boom truly gained momentum.  And though the biggest gains were seen by investors in the shares of ICE companies (information technology, communications, and entertainment), investors in equity schemes also saw significant gains, on account of the investments made by their schemes in these companies.  Consider this: over the fifteen month period from 1 Dec 1998 till 1 March 2000, 25 equity schemes and 2 balanced schemes saw their NAVs at least triple, while another 9 equity schemes and 4 balanced schemes saw their NAVs double.  There were 8 equity schemes whose NAVs went up 5 times or more, during this period.  Leading the pack was Kothari Pioneer Infotech Fund (now, Franklin Infotech Fund), whose NAV (adjusted for bonus units) astoundingly went up over 10 times during the same period.

An industry observer with whom I was speaking recently, had this to say about the gains during that period:  “Never before, or since then, has there been such an opportunity for the masses to legitimately make so much money, in so short a time.”

While the opportunity may have been there, the fact is that when the boom took off, very few people actually had investments in any of these schemes. Most investments in these schemes happened much after their NAVs had surged.  While this may be somewhat true of any bull market, in the case of the tech boom, this was partly because the sharpness and suddenness of the rise caught most investors by surprise, and partly because of a general lack of trust in mutual funds.

To go back a bit in time, the bear market from 1994 to 1998, on account of its prolonged tenure, had tested the patience of most investors,  particularly those in mutual fund schemes.  Funds such as UTI’s Mastergain 1992 (now, UTI Equity Fund) and Morgan Stanley Growth Fund (now, HDFC Large Cap Fund) had attracted large numbers of investors, but their investment performances had left a lot to be desired. Then there was the news of CRB Mutual Fund being wound up under charges of fraud.  Lastly, and probably, most significantly, UTI’s reputation took a major dent when it announced that the reserves on its flagship scheme, US 64, were wiped out and there loomed the possibility that it might not be able to meet commitments to unitholders in the scheme. 

It was not surprising, therefore, that most investors were naysayers or skeptics when it came to mutual fund schemes.  There were very few investors for whom the conceptual merit of investing in mutual funds remained intact in spite of all of these episodes.  When the tech boom took off (quite out of the blue, within months of UTI’s announcement), it was these few investors who gained the most.  In contrast, the naysayers and skeptics were left out for most of the rally.  By the time they shed their reservations to enter these schemes, the markets were into the last few months of the boom.  Given how late they entered the boom, the vigor with which these investors pumped in money, was truly astonishing .  To give some perspective, the gross investments into equity schemes in the quarter Jan-March 2000 were more than the total gross investments made into these schemes across the previous 11 quarters.  The net investments into equity schemes in that quarter were over 13 times the total net investments across the previous 4 quarters.  Obviously, these investors had no inkling of the brutal downslide that was to follow.

Over the nineteen months that followed the bursting of the tech bubble, most equity schemes saw their NAVs fall by over 60%, with some seeing a fall of over 80%.  As would be expected, investors who put most of their money around the peak were the worst affected.  Those who preferred tech funds (or funds with an overdose of tech stocks) were much more affected than those who preferred diversified equity schemes.  The differences were all the more starker for those investors who chose to hold to their investments for longer.  For instance, if an investment in a diversified equity scheme made at the peak of the tech boom were to have been held till today, the return on such an investment (without adjusting for loads) could range from 22% p.a. to 7% p.a. (most diversified equity schemes have given a return in excess of 15% p.a. over this period, which is the equivalent of growing one’s money by over 8 times). On the other hand, if an investment in a tech fund made at the peak of the tech boom were to have been held till today, the return on such an investment (without adjusting for loads) could range from 5% p.a. to 6% p.a. That would be equivalent to just over doubling one’s money.

But what about those people who were already invested by the time the boom gained momentum?  Returns in equity schemes over the 34 months from 1 December 1998 to 1 October 2001 ranged from 51% p.a. to –24% p.a. (without adjusting for loads).  Most equity schemes had gained enough on the upside to weather the downside and generate positive returns, with 10 schemes clocking returns in excess of 20% p.a.(without adjusting for loads).  Returns in Franklin Infotech Fund (the lone tech fund over this period) were close to 18% p.a.(without adjusting for loads).  If investments in any of the diversified equity schemes were to have been held till today, the returns would vary from 32% p.a. to 11% p.a. (without adjusting for loads) with as many as 28 schemes showing returns in excess of 20% p.a. (this would be equivalent to growing one’s money by over 19 times).  If an investment made in Franklin Infotech Fund were to have been held till today, the returns would be close to 22% p.a.(without adjusting for loads).  That would be equivalent to growing one’s money by over 24 times.

Would investing through a SIP have helped?  Obviously, those investors who invested large sums at the peak of the boom would have been better off staggering those investments. It would have particularly helped in the case of schemes which fell the most.  Consider this: A one-time investment on March 1, 2000, in the worst-performing, diversified equity scheme (based on returns over the entire cycle), would have taken nearly 8 years to double in value.  A monthly SIP in that scheme for 1 year from that date would have taken less than 6 years to double in value. 

Should investors have timed their investments?  As I see it, good timing involves getting two things right: the time of exit and the time of re-entry.  Getting even one of these wrong can have a significant negative impact on one’s returns.  Given the odds against getting both right, I do not advocate such an approach.  I do, however, recommend that one rebalance one’s portfolio in line with one’s asset allocation.  Looking back, I remember that some of my clients, against my advice, did indeed try to time their exit, and re-entry.  As far as I recollect, all of them would have been better off not doing so.

I’d like to share one last observation before I close this post.  It’s about two diversified equity schemes and highlights the fickle nature of equity performance and fund manager success.  The first was a scheme that did exceedingly well during the tech boom.  It was an iconic fund, managed by a ‘star fund manager,’ as people like to say. In the last fifteen months of the boom, its NAV went up over 5 times, and by some accounts, its performance in calendar year 1999 was a world record of sorts.  In the downturn, it fell sharply, losing over 70% of its value from the peak.  In the years since the boom, its performance has been patchy.  The scheme still exists but is all but forgotten, its past glory relegated to a footnote in the annals of history.  The other scheme was one whose returns during the tech boom placed it in the bottom quartile of equity schemes.  In the downturn, its performance continued to be unexceptional.  Yet, in the years since, it has delivered spectacular returns that have caused investors to regard it as an iconic fund, and its fund manager as a legend.  For those of us who like to predict future winners among funds, the tale of these two schemes should serve as food for thought.

Perspectives on Financial Planning

This post was triggered by a conversation I had with two people last week, both close to retirement.  The specific topic of our discussion was the management of finances after retirement.  My points were on the lines that I have mentioned in an earlier post but somewhere, I dropped the phrase, ‘financial planning.’  To this, one of them responded by saying something to the effect that he’d been doing fine without having to indulge in “Western concepts” such as financial planning.  When I tried to correct that impression, the other gentleman chipped in by saying that even if it wasn’t a “Western concept,” it was certainly a “new age concept,” most likely a “fad.”

Financial Planning is widely defined as “the process of meeting one’s life goals through the proper management of one’s finances.”  The term, ‘life goals,’ refers to events such as retirement, buying or building a house, the higher education of one’s children, or the marriage of one’s children.  Financial Planning requires us to ascertain how much money should be kept aside for these events.  It then involves aligning existing investments and investing future savings in a manner that maximizes the chances of having the required amount of  money when we need it.

Clearly, this description of Financial Planning would sound logical to anyone, anywhere across the globe.  Furthermore, in India, we have, for generations, been conscious of the need for financial security and have accepted it as our responsibility, to plan for our children’s future.  So what would explain the reaction of those gentlemen?

Their reaction was on account of their inability to link the phrase, ‘Financial Planning,’ to the concept of financial planning.  Even though the concept has been in practice in India for generations, we never gave it a name.  On the other hand, the phrase came to our wider attention only at the start of this century, but without any  linkage to the concept that we had already been practising.  To add confusion, there have emerged a set of advisors who, armed with a certification in financial planning, use the media to give the impression that good financial planning needs a sophisticated understanding, which investors (or even advisors without any certification) are incapable of possessing.

Financial planning is rooted in a recognition that investing is about more than just seeking high returns or the safety of our money.  The best investment decisions are those that are made in the context of our life goals.  The money that we save and invest, is best targeted at transforming our financial needs and aspirations into reality.  Whether we describe this as Financial Planning, or give it any other name, is immaterial. 

Many years ago, as I remember, the typical modus operandi for financial planning in a household would be to start by crudely estimating how much money would be needed for a future goal (such as a child’s marriage) and then figure out how much was needed to be saved based upon how long it would take for an amount to double in a bank deposit or a Post Office scheme.  All the families then had to do was to find the means and the discipline to invest that amount.  Distilled to its essence, success in financial planning has had a lot to do with the application of commonsense and financial discipline.

Yes, there are aspects related to the times that we live in,  that make the case for engaging a financial advisor.  In today’s times, most working people do not have the comfort of having an assured pension after retirement.  Furthermore, with progress in medical science enabling us to live longer, those of us retiring today are likely to spend more years in retirement than those who retired, say, twenty years ago.  In addition, there are many more things, small and big, that we would like to spend our money on.  The net result of all of this is that to achieve all our goals, a number of us will need to earn a return on our investments that is higher than what bank deposits offer.  In other words, a number of us would need to invest in complex options such as shares and mutual funds.  It is in respect to these investment options that a good financial advisor can add the most value by helping make choices that maximize the chances of us meeting our goals.  And to do that, in my opinion, a certification in financial planning is not a pre-requisite.