Be your own financial advisor

Of all the personal-finance problems that readers mail me about, the one category of queries that I find impossible to answer with certainty are the ones about needing a financial advisor. As someone said in a movie, the answer to that question is a definite 'maybe'. Actually, it's even more complicated than that.

The theory of what a financial advisor can do for you is straightforward. He asks you a set of questions about your savings needs and recommends a set of investments that will fulfil those needs. Then the advisor should tell you how to monitor those investments, or depending on the level of service, he should monitor them for you. If any of the investments do not live up to expectations or if your needs change, the advisor should help you choose alternatives and switch to them. Along the way, some investments, like equity, would face volatility that you may not have expected. During those phases, the advisor should act as a kind of counsellor and help you stay the course. If you need to generate some cash from your investments, then the advisor would advise you about which investments to redeem and how to go about doing so in the most cash-efficient way.

None of this is very complex and in fact, lots of savers quickly and intuitively learn all this from books, magazines and websites. However, many do not and then they need a financial advisor. Whether you would actually do better with a financial advisor or not depends not just on you but also on the actual financial advisor. As the saying goes, that's where the stuff hits the fan.

Some time back, I read an article in the US edition of Bloomberg.com on the widespread damage done to the finances of those who used the service of professional financial advisors. In one study, research workers pretending to be potential customers went to a large sample of financial advisors, asking for advice on the investments they were already holding. These existing investments were perfect examples of low-cost, diversified portfolios that such investors should in fact be invested in. However, a shocking 85 per cent of the financial advisors recommended changes to the portfolio that were objectively inferior but would generate higher commissions. Another study found that on an average, investors advised by brokers had returns that were lower by 3 per cent a year.

In India, we have all kinds of rules for financial intermediaries and yet financial advisors always act in their own interest. Whether it is insurance or mutual funds or stocks, behaviour is always guided by the incentives that exist for the salesperson. There's a huge pile of regulations in every area, and yet none of it is adequately effective in preventing bad advice. The reason is simple - there is not a single financial product where the interest of the salesperson is aligned to that of the saver/investor.

In some areas, such as mutual funds, the regulator has made an effort to cut down the upfront reward that the seller gets, but unless done holistically, this does not improve the larger situation. All that an advisor has to do is to guide savers towards other products.
It's a tough situation, and I apologise for not providing a definite solution. All I can say is that in any case you must make an effort to learn enough to be your own advisor.