Financial planning is a comprehensive process requiring hands-on experience and a strong understanding of tax planning, insurance, investments and retirement planning. In a portfolio, all of the above are linked and decisions need to be made in conjunction with an individual’s income flows, liabilities, assets and goals.
Bearing this in mind, it makes sense for individuals to take the advice of a financial adviser. That does not mean they should blindly believe what is told to them. Here are five questions you need to ask your adviser about every investment he suggests.
1) What is the basis for your recommendation?
Ask your adviser how many funds s/he actively tracks and the asset management companies, or AMCs, preferred. Don’t just obtain his white list, dig deeper. Ask for the reasoning behind the ones selected and the ones avoided. As an investor, you need to be able to comprehend how your adviser arrives at recommendations and the research process he employs.
The importance of seeking detailed information about the recommended funds cannot be overstated. Get a grasp as to how the fund has performed over various time frames. Does it collapse in a bear market and soars during a bull run? How has it fared vis-à-vis comparable peers and its benchmark index?
2) How often is the fund reviewed?
The next step would logically be to understand how often the recommended funds are reviewed. Just because a recommendation is made, it need not be forever. The fund manager could change. The fund’s mandate could change. The AMC may get taken over. Alternatively, the market may run up substantially throwing your desired asset allocation out of gear. In that case, the adviser needs to be able to suggest which fund’s units to offload or which one’s SIP needs to stop.
In other words, you need to understand why your adviser picked that fund in the first place and under what conditions he deems it necessary to sell.
3) How does the fund fit into my portfolio?
Every single investment must have a distinct role to play in your portfolio. In other words, investments should not be made on a stand-alone basis but a holistic approach must be taken. The fund’s investment mandate should determine the role it plays.
To elucidate, a large-cap oriented diversified equity fund could be a core holding and lend stability to the portfolio. Conversely, a thematic fund could be an apt ancillary holding. A mid-cap fund could be selected if you have 20 years to retirement and are willing to take a more risky approach.
On the other hand, it could be that you need to invest in an equity linked savings scheme, or ELSS, since you have to meet your requirements under Section 80C of the Income Tax Act. You need to ask your adviser what role each and every fund in your portfolio is intended to play.
4) Should I invest in an international fund?
There are plenty of international funds available in India, either via a feeder fund or direct investment in stocks listed abroad. Ask your adviser what his views are on having some exposure to stocks listed abroad. For instance, since India is classified as an emerging market, should the portfolio have an exposure to the U.S. stock market? Or alternatively, should one have a thematic exposure such as a global agri fund?
5) What option is recommended?
If you are paying your adviser a fee for his advice and services, then you should be free to opt for a direct plan from the AMC suggested. Also, if he recommends a dividend option, as against a growth option, do not blindly go for it.
In equity funds, a growth option is definitely a smarter choice. As the value of your investment grows, so does the net asset value, or NAV. If the NAV is Rs 20 per unit and the fund declares a dividend of Rs 2 per unit, after the dividend payout the NAV falls to Rs 18. Your own money is given back to you. Dividends from a mutual fund is just the return of investors’ money disguised as dividends- very different from the dividends you get from stocks.
There are exceptions. If you need need some cash inflows periodically, your adviser may suggest a dividend option.
The above questions are just guidelines to understand the thought process of your adviser. Don’t shirk from doing so. After all it is your money at stake.
