Of Barbers and Brokers: Why it is important to know what you are looking for

Every few weeks, Saturday mornings are reserved for the barber. Today was one of those, so my son and I had our visit to the salon. After our customary drive and parking, and a few minutes of waiting for our turn, we finally were called in and sat into our ‘throne’ to get started with his ‘services’. Mind you, salons in major cities in India have got quite savvy. So unlike a few years back when you just went to a barber shop to get a haircut, now you go to a wellness salon which provides ‘overall hair and beauty services’. They have a quite a range of services on offer to grab more ‘share of wallet’ from you.

But despite that some things have not changed. So the first question I get when I am seated is still – ‘do you want it cut short, medium or long?’ I have never been able to figure out what to answer this question with. Obviously, long is out of question, else I would not be here. But between short and medium, I have never figured what I really want. When I say short, I kind of need to clarify that I do not want an army crew cut. When I say medium, I generally follow it up with some comment that suggests – but do not cut just a bit! After that, I hope he has got what I want and then silently sit waiting for him to do his job.

This is similar to the ‘agony aunt’ stock question-answer programs you have on TV. So the caller asks – I bought so and so stock at Rs.100 two weeks back – what should I do now, buy, hold or sell? And the advising broker asks him – can you hold for short-term or long-term? Similar to ‘do you want your hair short or medium?’, this question has no clear answer. So the caller answers, long-term, and just to clarify – adds 2-3 months!! Providing clarity for his definition of long-term.

The other similarity I find between barbers and brokers (or as they are called hair and beauty service, and financial service providers respectively) – is their nice guy approach when the first service is over. So I am nearing the end of my hair cut, and typically I am asked – “Sir, will you like a hair color?” Now at this point, if I am not clear on whether I want it or not, it is quickly followed by something like – “It will look good on you Sir” or something to that effect telling me why I need it. Depending on the tone of my answer, the same service is pursued, or a new item in the menu card is proposed – the hope being that the 5 minutes between now and the end of my hair cut yield an add-on service that I purchase.

This is again similar to my experience with financial services providers of late. If I visit a bank, a ‘relationship manager’ arises from somewhere telling me that he will be the point of contact for me. So after some mundane task like submitting an application for a bank stamp on an ECS mandate is done, and I am waiting for the processing, the relationship manager quickly asks me if I am looking for stock and mutual fund advisory services, or else for insurance, or for credit cards – for something. A little bit of confusion shown on my face, and I am drowned in information on why I need it. Only when there is no option but to give me my ECS mandate, I am free to go.

So here we are, in the savvy new world of services with so many things on offer. A slight bit of confusion on your face is a sure sign for marketing spiel to follow. In such a scenario, whether it is barbers or it is brokers, it is important that the buyer is clear on what he wants, and not just that, is quite staunch about it. An extra hair color at a salon may not cause much harm, but a wrongly bought financial service or product is likely to do so. So as has been said by famous investors earlier, never ask a barber if you need a haircut (or for that matter any other hair and beauty service). It is in your interest to be clear about what you want. If at all you have a need to ask, ask someone whose advice you trust and will provide advice that is in your interest. Because whether it is a barber or a broker, like Lewis Carroll said – “If you don’t know where you are going, any road will get you there.”

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Insurance is not Investment

It is an indication of the sorry state of affairs in investor education that market linked insurance schemes get more fund inflows than mutual funds in India. The war between the capital market and insurance regulators was never fully resolved, though it led to some changes in structure of market linked insurance plans, and perhaps a lesser complex cost structure. It did not solve the issue of higher commission payouts to insurance salesmen, though it left mutual fund companies in the lurch – due to their inability to pay commissions to their distributors. Of course, a smaller evil cannot be a solution to a larger evil – and the world is not a perfect place – so while things have improved, the fact remains that investor education is still so low that financial products get sold rather than bought.

insurance-notinvestmentThe fact of the matter is that everyone needs insurance, and everyone needs investment solutions. More important than that, everyone needs an ability to differentiate between the two, and a discipline to stick to the differences. Nobody except the companies selling them needs market linked insurance products. An individual needs adequate levels of low cost insurance, and a clear investment plan. A mixed product like market linked insurance product simply combines the two, adds some complexity to make it a nice sales pitch, and eventually depends on the investor’s confusion and the salesman’s skills to collect the premium.

Insurance is a game where you take a bet on your longevity, and pay a premium to protect against unexpected death or loss of earning power. The only basis for selecting insurance should be a product where the odds are in your favour – in the form of a low premium for a large insured sum, preferably at a young age. Investment is a game where you take a bet on the future earning capacity of an asset, and pay a price which you think is lower than the sum of future earning capacity. These are two unrelated things – and combining savings or investment plans with insurance – is like adding apples to oranges. The only excuse to go for a market linked insurance product instead of a mutual fund can be an investor’s lack of discipline which an insurance product provides no escape from, unlike a mutual fund or stock which can be sold in panic. But that is more an investor’s problem to solve through better education and self-discipline rather than locking himself to a high cost product.

If an investor has education and self-discipline, there is no reason whatsoever for him to go for a market linked insurance scheme – which is simply high cost investment in disguise. And in the absence of education and self-discipline, it is unlikely that anything can help him.

Attention Surplus Disorder: Are you paying for paying too much attention?

We have all heard of Attention Deficit Disorder – which refers to the lack of an ability to concentrate on an activity or task – something on the lines of low attention span. I have often been (and I guess a lot of individual investors will also identify with it) a victim of what I will call here as Attention Surplus Disorder when it comes to investments.

This is the state in which you pay so much attention to your investments (than is necessary) that it leads you to take actions that you should not or would not ordinarily take – if you were not paying surplus attention. With all the business newspapers, television channels, stock tickers, online portfolio statements, websites and email, there is a high likelihood that a lot of investors (and I refer to people who honestly start with an intention of long term investing, and not traders or speculators) are victims of attention surplus disorder.

A majority of the financial services industry and its revenue is essentially based on two sources: One is the size of your assets, and Two is the amount of your transactions. A third source, in a few cases, is a percentage of your profits. Most constituents that ordinary investors deal with make money based on a percentage of either of the first two. It is in their interest, therefore, that you either suffer from or are made to suffer from Attention Surplus Disorder – in the hope that you will then be motivated to do something that leads to either newer assets or newer transactions.

So all the clutter (a.ka. analysis, views, news or similar) to get your attention to your portfolio and to the markets – with new technical and fundamental analysis everyday, how which stock is best to sell now or buy now, or how some mutual fund beats the index this month, quarter or year versus some other last year, month or quarter; or how you should add new asset classes to or change your asset allocation of your portfolio – and much more – are all essentially noise that gets your attention, and leads you to become a sureshot victim of attention surplus disorder. It is likely to take an ordinary investor a lot of education first, and then a lot of will power and discipline next, to get himself into a position where he escapes becoming a temporary or permanent victim of attention surplus disorder.

5 Steps to Simplifying Portfolio Strategy using Asset Allocation

A lot of individual investors are so interested in getting answers to questions like which stocks to buy, at what price and when to sell – that they do not realize that these are the least important questions to get answered when it comes to building long term wealth.

Perhaps the single most important decision that influences long term returns has got to do with allocation ratio of asset types. That is – how much of my income after expenses – i.e. savings – do I put in various types of assets across stocks, fixed income, real estate, gold and cash? This is broadly referred to as portfolio asset allocation in financial parlance – and is the single most decision that impacts long term returns.

assetallocation

For simplifying portfolio strategy, all the opinions and advice can be essentially reduced to, in my view, a set of few simple steps:

1. Decide your asset allocation based on your life circumstances: For an individual who does not intend to do investments full time (i.e. has a job or business for his regular income), an allocation of up to 60% in equity, 10% in gold and the remaining 30% in cash and fixed income might be the optimal allocation. It may not give best returns, but is likely to be something that is practically followed over the long term.

2. Select your core and peripheral assets within the allocation: For most individual investors, index funds or select actively managed mutual funds are the best vehicles for equity participation.

3. Review once a year, and Rebalance when allocation ratios go out of whack: i.e. if equities have grown and now account for 70% of assets, shift 10% into others by selling; similarly if cash/fixed income or gold value has increased, shift proportionately into equity.

4. Set up a system for this: both contributions and rebalancing, so that you do not have to take decisions frequently.

5. Keep increasing absolute amounts or relative asset allocation, as your income levels increase or decrease, life circumstances change or ability to take risk alters.

This can be a framework for deducing a simple investment portfolio strategy for most individual investors. Once this is set up, the investor is likely to realize how unimportant the question of which stock to buy and when to sell really is.

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