The article initially appeared in Firstpost and has been written by Dhaval Kapadia, Director, Portfolio Specialist, Morningstar Investment Adviser India.
People typically seek financial advice from friends/relatives or from someone whom one believes has got investment insights. There could be a variety of reasons due to which people take investment advice from their friends/ relatives or colleagues.
First, money and investments are personal issues and people would tend to trust close friends or relatives for providing advice.
Second, lack of awareness of the spectrum of financial products - financial literacy is limited and people are generally aware of only a limited number of investment options, at times those that their friends or family have invested in like fixed deposits, gold, insurance policies, PPF, real estate, etc.
The awareness of other investment options such as mutual funds and their role in helping achieve one's financial goals is limited.
Third, lack of access to a trusted and professional advisor - most retail or first-time investors would have limited or no access to expert advice due to the low advisor to population ratio (there are less than 200,000 registered active mutual fund distributors and advisers including employees of banks and wealth management firms involved in distribution of investment products across the country).
However, taking investment decisions based on advice provided by non-qualified person may not always serve the purpose. It is akin to seeking remedy or diagnosis of a major illness from a chemist or a friend without relevant qualifications / expertise.
Each investor has a different risk tolerance. Much of the difference in risk tolerance stems from one’s investment horizon. That is, someone with a short investment time horizon is less able to withstand losses. The remainder of the difference is attributable to the individual’s appetite for risk. Investing and financial planning is a specialized subject requiring expertise, specific qualifications and relevant experience.
Each category of financial instruments or asset classes have specific characteristics, for instance fixed income instruments like Fixed deposits, bonds, debt mutual funds, provide safety but may not be able to beat inflation and be unable to help achieve one's long term investment goals due to low returns. Whereas, equity which can be volatile in short term has the potential to generate higher returns over the long-term vis-a-vis fixed income instruments, beat inflation helping achieve one’s long term investment goals. Similarly, other asset classes such as international equity, gold and real estate have different risk and return characteristics.
Understanding an investor's investment goals and accordingly constructing an investment portfolio consisting of various asset classes in suitable proportions requires an expert and qualified adviser. Obtaining advice from informal sources might result in limiting one's investment options to a single or only few investment options which may not be suited to one's investment goals and risk appetite.
Providing investment advice requires addressing a variety of priorities and concerns. A skilled professional with requisite qualification and experience is in a better position to offer sound investment advice with required reasoning. As an investor, one needs to consult a certified professional financial adviser with relevant experience, who would understand one’s risk appetite and investment goals and accordingly offer investment advice.
Investors should also insist on documenting risk and return objectives and any form of constraints as a part of investment policy statement.
The statement serves as a guide to planning and implementation of an investment portfolio and establishes accountability. It is also important for investors to understand the rationale behind investment recommendation or advice. Prior to agreeing to recommendations an investor should understand the rationale for the advice offered and have their concerns and queries addressed. It is also important to know whether the advice given is aligned to one’s investment goals.
The capital markets regulator, Sebi, has categorized individuals and firms that offer investment products like mutual funds, PMS, etc. into two broad categories – i) Distributor and ii) Registered Investment Adviser (or RIA). Mutual fund distributors typically offer limited investment advice and earn commissions from the product provider i.e. Asset Management Companies. Whereas, RIAs typically provide comprehensive financial and portfolio planning services for which advisory fees are charged from the investor. They may not obtain commissions from product manufacturers.
As an investor, it is essential to understand whether your adviser is a distributor or RIA and whether they have internal policies in place to avoid conflict of interest arising from how their commissions are earned. This may result in only products with high commissions, which may not be suited to one’s investment objectives, being offered.
