It is always recommended that investors should consult with a financial advisor before making an investment. Good financial advisors have helped many investors meet their financial goals through the right advice and proper execution. On the other hand, incorrect financial advice can compromise the investor’s progress towards their financial objectives. Lack of professional knowledge and experience can cause a financial advisor to give a wrong advice. Some advisors, hopefully a small minority, may be motivated by commercial considerations that benefit the advisor but not necessarily the investor. Either ways, it is the responsibility of the investors to make sure that they understand the rationale of the recommendation given by their financial advisor, before they authorize the advisor to execute the transaction. In this blog, we will discuss five signs that your financial advisor is not giving you the right advice.
Sign 1: Asking you to invest in Mutual Fund NFOs because the units are available at
र 10 (par value)
Do not think that NFO’s are cheap because they are available at par value. Par value of a mutual fund unit is meaningless, because the unit by itself has no value. The unit derives its value from the underlying of stocks or bonds or a combination of both. Funds whether NFO or existing, invest in the same universe of stocks at market price. An NFO at
र 10 may have expensive stocks in its portfolio, whereas an existing scheme with an NAV of र 400 may have stocks at attractive valuations in its portfolio. In that case, the scheme whose NAV is 40 times higher will give better returns than the NFO. We are not suggesting that you should not invest in NFOs. You should make sure that you invest for the right reasons and not because the units are available at par value. You should understand the investment objectives and the strategy of the fund manager. You should research the track record of the fund manager and the asset management company. You should also make sure that you are comfortable with the liquidity and exit load of the investment.
Sign 2: Recommending close ended schemes because they give better returns than open ended schemes
Some financial advisors tell their clients to invest in close ended schemes because they think that, close ended schemes can give higher returns that open ended schemes. They argue that, since there are no redemption pressures in close ended schemes, the fund managers can stick to the high conviction stocks which result in higher capital appreciation over the investment horizon. While the argument makes some sense, the counter argument is that open ended schemes are more actively managed and the open ended fund managers are more pro-active at identifying opportunities as they emerge in the market. The bottom-line is that, there is no compelling statistical evidence that close ended funds have given higher returns than open ended funds. Some close ended schemes have given excellent returns comparable to best open ended schemes, while many close ended schemes have underperformed. Close ended schemes can be excellent investment opportunities. However, you should make sure that you understand the investment strategy of the fund manager. If the close ended scheme is part of a series with a common investment strategy, you should research the performance of the earlier schemes in the series. It is also important to make sure that you are comfortable with the lock-in period of the scheme, in the context of your overall financial situation and goals.
Sign 3: Asking you to invest in "good" funds because they are paying high dividends
Investors should understand that mutual fund dividends are paid from the profits of the scheme. Unlike a stock dividend, a mutual fund dividend does not imply surplus cash flows. Therefore if a scheme pays dividends, it does not imply that it is better than a scheme which does not pay dividends. The dividend that the fund pays is adjusted from the NAV. It is always recommended that investors should look for total returns, which includes both capital appreciation and dividends, instead of being just focused on dividends. Paying high dividends is sometimes a marketing gimmick to get more assets under management (AUM). Some of us will recall that a few years back, some ELSS (tax saver) funds were paying very high dividends on regular basis. With the benefit of hindsight, now we know that it was not a good decision, because it ultimately impacted the NAVs of these funds. Paying high dividends may have a bad effect on the NAVs, because if the fund is committed to paying high dividends irrespective of market conditions, they will end up selling their best stocks and buying them again at a higher price. After sometime this will start impacting the NAVs negatively. If you need regular income, you can opt for dividend option of good funds, but you should make sure that you do your homework in researching the performance of the fund.
Sign 4: Asking you to book profits in the funds where you have got very high returns and re-invest in other funds
This is a disastrous advice, which many investors fall for. Other than the psychological satisfaction of booking profits, there is no other benefit in booking profits in your best performing funds. Investors should understand that the best performing funds are likely to outperform in the future as well. By booking profits in your best performing funds, you are taking money out from a good investment and possibly putting it in a not so good investment. In other words, you are giving up on future returns. You should redeem your best performing funds, only if you need the money for your financial goals. If you or your financial advisor identifies a great fund which is not there in your mutual fund portfolio, you should either make a fresh investment or sell your under performing funds.
Sign 5: Asking you to split your monthly investment into a large number of SIPs with small instalments
If you want to make a monthly investment of
र 10,000 there is no benefit in splitting into 10 monthly SIPs of र 1,000. Some financial advisors may ask you to split your investment into smaller parts for the sake of diversification, but this often leads to over-diversification with no benefits. Investors should remember that a mutual fund scheme itself, is diversified across sectors and stocks. Therefore investing in a large number of schemes, does not necessarily improve diversification. On the other hand by investing in a large number of schemes, you may end up investing in schemes that are not performing that well. The other issue of investing in a large number of SIPs is ensuring sufficient balance in your bank account or accounts on all the different dates the monthly instalments are due. If have a fewer number of SIPs, then you just have to ensure that there is sufficient balance in your bank account on the few dates the monthly instalments are due.
What should you do if you think that your financial advisor is not giving the right advice?
The first step is to increase your own investment awareness. Unless, you are yourself aware you would not know if the advice is right or wrong for you. The second step is to increase your engagement with your financial advisor. You should discuss the rationale of every recommendation given by your financial advisor. You should make it clear to your advisor that if you do not understand the investment logic or rationale, then you will not be comfortable making the investment. You should also make sure that the financial advisor understands your investment objectives. The first and second steps will go a long way in helping you make the right investment decision. However, if you still think that your financial advisor is not giving you the right advice, you always have the option of looking for a new advisor. However, the critical success factor in ensuring investment success is to increase your own investment awareness.