Three behavioural biases that can ruin your portfolios

Awareness & consciousness of the biases would prevent one from stepping on the banana peel of wrong conclusions.

We all think we are rational beings and we take decisions or arrive at conclusions after weighing the pros & cons of the situation. We also take into account all the data available before arriving at a decision or conclusion. But, still, many of the decisions or conclusions we take turn out to be really wrong, which leaves us scratching our heads. We wonder - Where have we gone wrong?

It is not that we may actually be wrong, but there are entrenched thought patterns which may lead us astray. We may not even be conscious of this!

We need to understand first where the biases are coming from & what some of those biases are. Only when they understand that, can it be tackled.

Hindsight Bias – We are not oracles or soothsayers. Hence, we would not be able to anticipate which events will happen or how it will unfold. But after the event, it all seems so logical and even cogently explainable. This is irrespective of how improbable they thought the event was, before it occurred.

Psychological experiments prove this. Baruch Fischhoff demonstrated this “I knew this all along” effect, through an experiment. Fischhoff conducted a survey on possible outcomes of Richard Nixon’s trip to Russia & China in 1972 and asked people to assign probabilities to various events, before the trip. When the trip was done & he went back to the same people, there were surprises in store.

Whichever event had actually occurred, people exaggerated the probability they had assigned to that event. If it did not happen, people said they always felt it would not happen (though the probability they assigned before that event was higher )! After the event, everything seems so logical & plausible, that we automatically adjust our memory to align with what is now known!

Hindsight bias has huge implications for all of us. For instance, if during a routine surgical intervention an unpredictable accident caused the death of the patient, it will most probably be believed that the doctor did not assess the situation properly & went in for a risky procedure! The benefit of hindsight & knowing the outcome alters how people perceive what the doctor had done. We come to the wrong conclusions due to hindsight bias!

There is also another bias lurking out there. It’s called outcome bias.

Outcome bias – Blaming someone for a good decision which worked out badly & giving too little credit for good moves, that, with hindsight, looks all too obvious, is outcome bias in action. When outcomes are bad, people would blame the decision makers for not seeing the writing on the wall, in spite of prudent decisions that the person might have made with the information available, at the time of the decision.

This again is proved in psychological experiments. In case of 9/11 type incidents, the officials concerned seem negligent, even absolutely irresponsible after the event. CIA had intelligence inputs to indicate that Al Qaeda was planning a major attack, which went to the National Security Adviser. This was not escalated to the President, which was questioned after the event. It did not go to the President as it was one of the many intelligence inputs that CIA got and this one did not look specifically significant.

Predicting outcomes is extremely difficult as there are so many variables affecting an outcome. And yet, after the outcome is known, we all tend to judge all those who were involved in that process, based on how it turned out!

Action Bias - There is another important area where we all go wrong.

Financial advisors are expected to keep shuffling portfolios or keep doing something, in their quest to advise clients. That is why advisors who tell their clients to just stay invested or tell the clients that no changes are needed in their portfolios, are not that popular. People like action. Those that are constantly seen to be taking action are seen as dynamic & proactive. This is called the action bias.

The good advisors who advised clients against unwanted churn are not fully recognised for their wisdom, even if they ended up with good returns. The client thinks that the markets have done so well that the returns they have got would anyway have come and advisor contribution is not much (the advisor did not even suggest any actions in between and asked us to stay put). Even a very good outcome can act against a person. This is a case where outcome bias & action bias are acting in concert.

Action bias is seen even in sports. In a penalty kick, there is a penchant for the goalie to jump to the left or right without knowing the intention of the kicker. Had the goalie been standing in the middle, he would have probably saved more goals. That’s what studies suggest! The goalie does not want to be seen as slothful & the viewers equally expect him to dive to the left or right, instead of planting himself in the middle. That is the classic action bias at work!

What can we do - Knowing that these biases exist is helpful, but that knowledge by itself cannot prevent these biases from asserting themselves.

Before coming to any conclusions, one needs to examine whether it is tinged with any bias that may lead one astray. Awareness & consciousness of the biases would prevent one from stepping on the banana peel of wrong conclusions. Wrong conclusions lead to more wrong decisions. Mind does play games - but we can avoid being kicked around, if we are alert.

Article first published on:
Moneycontrol - Three behavioural biases that can ruin your portfolios

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

The kingdom of the Gods!

There is so much work. Yet I took a holiday to go to Bhutan to rejuvenate to take on responsibilities that lie ahead. I'm glad I did. 

Bhutan is an amazing place. The entire country is like a spa. You need not necessarily visit all the places. Being there is therapeutic. Have come back revitalised & suitably impressed with the country which measures it's riches on the happiness scale.

Here is my travelogue on Bhutan -

​​​

 The kingdom of happy people.pdf

​

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

The Bamandayapada Syndrome

                                                                                Picture credit - www.pixabay.com

A long time ago, I had gone to meet one of my clients, in a place tucked away in one corner of Andheri ( a suburb of Mumbai ). The first time I went there, the place was a revelation. I had never ever been there before. It was a quiet place – a real cul-de-sac which was quaint and removed from the hustle & bustle of Mumbai. 

But was reaching there convenient? Would I want to stay there? No, not really.

Reaching there took time and some autos did not want to come there. They said they don’t get any customers there! When I met my client and asked him about the place, he was raving about it as if it were Hawaii, Sikkim & Simla rolled into one!

He pointed out the obvious attractions – the place was quiet even though it was in Andheri, you could get everything you need in the nearby shops, good neighbours, it was connected by buses, the place is just somewhat away from the arterial Andheri Kurla Road ( which is just as well! )…

I got to know that he had spent quite some time here. And had got quite attached to the place called Bamandayapada, where his home & hearth was!

It has the attractions that my client had pointed out. But you can find cul-de-sacs in many places, with shops vending what-have-you, buses plying to and fro & the place being in the vicinity of some could-not-miss attractions.

In fact we may all be able to romantically describe our homes with bated breath. All of us get attached to our places, our homes, our possessions etc., sometimes bordering on the irrational. 

We feel that our home is somehow special – located as it is 500 meters from the arterial road, not far from malls & theatres, with sunshine streaming into the bedroom after the winter solstice, has some green cover when we see at 135 degree angle from the bedroom window etc.!

Reason enough to call this The Bamandayapada Syndrome!

The syndrome is a behavioural quirk. If it is not going to affect us, we need not be so bothered. But it is going to affect us deeply.

For one, such deep, entrenched thought patterns ensure that one would make debilitating mistakes in life, due to this. This happens all the time with real estate. 

We tend to overvalue our property due to our perceptions of what we feel are enticing plus points of the property we own. Our property somehow seems special to us. Due to such perceptions, the owner of a property tends to expect a good premium on the house. Real estate market is replete with people sitting on unsold property for years, for this reason. Bamandayapada Syndrome is fairly common among home owners.

Many such people would wait for years to “get their price”, in the bargain actually losing money. For instance, if the market price of a home is Rs.1 Crore & the owner is expecting Rs.1.25 Crores & decides to wait and finally sells after 4 years at Rs.1.25 Crores, he has actually lost money – for Rs. 1 Crore four years earlier could have earned much more than just Rs.1.25 Crores, which he earned, four years hence.

It’s very pronounced in real estate. But this is hardly true of only real estate. This is true across the board. And in psychology, it has a name – Endowment Effect, where something that we own, seems much more valuable to us, than it really is.

This is true for anything we possess – cars, collectibles, our equity shares, even our children. We all have heard of mothers singing paeans about their daughters, which generally leave their husbands wondering if it is the same woman they were referring to! That’s endowment effect again!

The term endowment effect was coined by economist Richard Thaler for under weighting opportunity costs of goods that are a part of their possession than others which are not.

There is a famous experiment done by Daniel Kahneman & others, in which the participants were given a mug and were given a chance to trade it with an equally valuable item, in this case a pen. They found that compensation sought once the ownership of the mug has been established ( willingness to accept ) was twice as high as the price they were willing to pay to acquire the mug ( willingness to pay ).

This is a behavioural anomaly. We can make mistakes arising out of this. We need to be watchful to not fall prey to this. The most important thing here is to recognize it, before we get sucked into it. Knowing is the first step to handling it. When in doubt, it is better to get a third party opinion and then take informed decisions. That way Endowment effect cannot overwhelm us!

Article first appeared on Linkedin:

The Bamandayapada Syndrome

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

The elusive quality that brings the world to their feet

The shopkeeper finds out why you are buying a product & sells a basic, low price product as your requirement is such.  The refrigerator mechanic looks at the fridge & finds that it is not cooling properly as a plastic bag was blocking the air vent. He takes a nominal Rs 100 for the visit and refuses to charge the usual Rs 500, as there was no work involved. An insurance agent asks why you want to buy a policy and when he understands that you don’t require insurance otherwise, suggests investment in PPF.

 Do these things happen in real life? They do happen… but very rarely.  There is a vested interest in all of us and we all act based on what is in our best interest. This happens across industries. The self-interest is so strong & our greed so endemic, that self-regulation seldom works. We see excesses in virtually every industry, even though some of them are regulated. 

The 2008 financial crisis itself can be traced to such unbridled greed which led to the birth of exotic instruments that couched the true nature of the underlying products. It was a deception & a fraud of such proportions, that it precipitated a global crisis. Selling unsuited, costly products is a malaise worldwide in the financial services industry. 

Volkswagen was an example of fraud in the automobile field where they had a cheat software that got triggered, when emissions were measured. Medical field is replete with unethical practices – doctors suggesting costly medicines in collusion with manufacturers, suggesting unwanted procedures, suggesting C-Section when normal birth would have been fine etc. Recently, National Pharmaceutical Pricing Authority of India has brought down the stent prices to between Rs 7,000 to Rs 30,000. The stent manufacturers and importers were making profits between 250% to 1000% & the citizens were reeling under the onslaught of high medical expenses borne out of profiteering & lack of scruples. 

This is happening in industry after industry. We have become accustomed to people taking advantage of us, in every way. We are perpetually forced to be on the lookout. Caveat Emptor is the reigning sentiment with people – they have no choice. 

Consumer protection is hence raising its head everywhere & the incumbents are not liking it, one bit.  But, once there are regulations, does it work? Not always. 

Regulations impose the base minimum standards which an industry participant has to comply with. In industry after industry, regulations are complied with grudgingly and to the minimum extent possible. But that is hardly the intent of the regulation, which assumes that the participant will take the regulation as a guiding factor & rise well above the minimums, which it seeks to impose.

 In financial services industry too, regulations have been closing in as the citizen at large had been taken for a jolly ride. More than in any other field, financial services impacts the well-being of a person, nay, their very survival based on what financial decisions they take and which products they buy. 

This is where ethics come into the picture. Ethics are the moral principles which govern a person’s behavior. Some people are endowed with it. Many others are not blessed with it. That is why regulations are required in the first place so that they can prescribe the basic minimum standards to adhere to. This then becomes the hygiene factor; the bar which everyone needs to jump over. 

But in every industry, we need torch bearers who will go far beyond the call of regulation. That is when the industry will acquire credibility & respectability. 

Fiduciary standard is now becoming an important component – often the centerpiece of the financial services regulations worldwide. This is a higher standard which imposes huge responsibility on the adviser, whereby the adviser places the client interest even higher than one’s self interest. Hence, the regulation of today may seem bullet proof. But even here, those that want to merely comply with regulations can get away with doing the minimums! 

An example – in the Investment Adviser Regulations 2013 by SEBI, fiduciary standard is imposed on those coming under the regulation. This regulation also imposes other responsibilities like getting remunerated by client only and not by product manufacturers. The intent in this case was to create true blue advisers who are completely aligned with client’s interests and who represent only their clients. 

I heard some advisers the other day discussing about whether SEBI RIAs can sell products coming under the purview of other regulators. To me, the question looked self-evident – one cannot sell any commission bearing product whether the product comes under the purview of SEBI or not. That’s because of the principle of representing the client’s and their interests alone and not having any conflict of interest. If one were to have inducements in the form of commissions, an adviser cannot rightfully say that they are acting only in their client’s best interests. They may probably be complying with the regulation in form but certainly not in spirit. 

This essentially is the problem. When you buy a bathing bar, there is nothing wrong with it. But it is not a soap, which the customer mostly thinks it is! When you buy a tea blend thinking it is tea, again nothing wrong there. But read carefully – it has a whole lot of things other than tea, like tapioca! Are these manufacturers misleading people? From regulatory standpoint, they may not be. But, ethically, they are misleading the public by offering something and leading them to believe it is something else. 

Ethics is a scarce commodity – in finance & elsewhere. Finding someone who acts in the true spirit of the professional standards who goes beyond the call of mere regulatory requirements are those who become legends in the profession. 

Let me end with an anecdote. A sculptor was bringing to life a statue. An onlooker sees another similar statue in the room and asks whether he is creating another one of the same type. Continuing his work, the sculptor replies that the other statue is flawed & hence he is creating a new one. The onlooker inspects the other statue and is not able to find any flaw. Intrigued, he asks the sculptor as to where the flaw is.

The sculptor stops work, walks around to the other statue and points to the nose, where there was a small chip on the otherwise flawless nose. The onlooker then wanted to know where the statue would be placed. The sculptor, shows him a place high above on the temple roof. The onlooker is very surprised – “If the statue is going to be placed 40 feet above the ground, no one will know there is a flaw. So why are you making another statue?”. The sculptor quietly says,” But, I know it has a flaw!” 

That is what integrity & ethics is all about. It is what you display when no one is looking. It may be difficult to comply with such high standards. It’s rare. It’s priceless. That’s why those who have it, are valued very highly – they straddle their profession like a colossus.

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

What is fair compensation for your adviser?

If the charges are almost static, there is no incentive for the adviser to perform,

Change is a constant now in the financial services space. The financial community has had to adapt quickly to the fast-changing regulations. 

Here is one change. Financial service providers had traditionally been selling products and bundling incidental ‘advice’ with them, for ‘free’. All good, but the problem was that the distributors’ were guided by the interests of the principal and of their own. While customers thought they was getting ‘true’ advice, they were being sold what the distributor wanted to sell. Apart from that, often, distributors did not have certification, hence their ability advise was constrained. The Securities and Exchange Board of India (Sebi) introduced the Investment Advisor Regulations in 2013, so that customers had access fiduciary advice. These Registered Investment Advisors ( RIAs) were prohibited from getting commissions; their remuneration had to come directly from the customers. Today, there are over 530 RIAs. 

Worldwide, there is a debate on the fee-based model. There are also those who vouch for the asset-linked model. They say that as the value of assets goes up, so does the complexity, hence expertise and more time is necessary to manage them. 

The other argument is that if advisers nurture clients’ wealth, they should be allowed to participate in the upsides too. A CFO in a company is well compensated as her acumen in managing the financial affairs of the company is vital. The compensation reflects the value added, and not just the time spent. The same holds true for a ‘personal’ CFO, which is what an adviser is.

Even in the investment field—mutual funds, insurance, portfolio management services—the prevailing and accepted model is to charge fund management charges as a percentage of assets. Apart from these, there are management fees, premium allocation charges, policy management charges, and profit sharing too, in different products. 

Those who disagree with the asset-linked model opine that the effort involved in managing a Rs1 crore portfolio is not very different from managing a Rs1.5 crore portfolio. Hence, the extra charges are unwarranted. Again, there is again some truth in this. 

But if the charges are almost static, there is no incentive for the adviser to perform. The costs for an adviser are going up and without a compensation structure, the relationship will not work. So, is there really an alternate model? There is.

A project-based compensation model could work well when there is a clear-cut project that needs to be completed and delivered. A financial plan would work well under this model. After this, various services can also be accessed a la carte. This means that a customer could opt for some services and not others. So the adviser-client relationship is an on-off affair and not a continuous one. The disadvantage is that the adviser does not have a regular source of revenue. Plus, she also does not have an overall control over the client’s financial well-being. So, the amount an adviser could earn is capped, and scope of engagement is limited.

If a project-based compensation model was the best model, the corporate world would have only consultants and no employees. 

Consultants need to have many rods in the fire as a project has a specific tenure. After one project is done, they have to move on. They would receive less and their long-term engagement is at the whims and fancies of the client. From the customer’s point of view, they would be paying less and would be getting a less engaging relationship too, in this project-based model.

There are advantages and disadvantages to both models. Which model the client wants to choose, depends on how deep she wants to engage with the adviser. The asset-linked model enables a deeper engagement. The adviser is invested in the customer’s future and is the client’s CFO. The benefits in this engagement could be high, though the fees paid will also be more than in the other model. 

The project-based compensation model would allow the client to pick and choose what she wants. This pre-supposes the client’s clear understanding of what is useful for her—it may look straightforward but may actually be complicated. Most people don’t know what all is needed to live a financially well-funded life. So, with this model, they may pay less but also achieve a lot less. 

The fee alone should not be a determinant while choosing a model. Rather, the choice should be based on the value an adviser could add and whether they can live a fulfilling life, bereft of financial worries. But it’s best to leave it to the wisdom of customers to choose what is best for them. 

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

The coming tech-tonic shift in financial services space!

Technology is an enabler. Tech is used to make things easier, ensure good quality at low cost, remove mind-numbing repetitive jobs and act as an aid to mainline functions like Sales, Finances, Manufacturing etc.

The role of tech has slowly changed. From being an ancillary function, they have started occupying centrestage – across industries. In many new age businesses, technology is the heart itself.

Technology as a disrupter - Seismic shifts are happening across industries & is going to make a whole lot of people & current processes redundant.  Technology also will create many new jobs – but many of these jobs will be highly skilled jobs, which has a high entry barrier.

Whoever thought an app can disrupt taxis/ autos!  Drivers stare at the prospect of losing their livelihood as more and more people choose to travel using Ola/Uber. People may not feel the need for cars at all in future – at the least, multiple cars will go away if a car is just a click away, any time of the day or night.

Driverless cars are another trend that may mainstream, maybe in the next 5 years. This has huge implications not just for drivers but for car manufacturers as well.

If driverless cars and carhire services are the future, then the number of cars sold could plummet. The way taxi aggregators operate itself will change. There will be, say, 200 depots throughout the city & the driverless cars will pick/drop a passenger nearest the depot & return to the nearest depot, till it is hired again! This way the number of cars required to service the car using population could probably come down by a factor of 10 – that could be a worry for the auto companies.

Again tech is disrupting a lot of other areas. Eat out/ Restaurants industry, for instance, have both been benefitted & buffeted by technology. The reach of restaurants in an area has increased due to apps, but many times, they are also forced to lower their rates.  Now, the traditional restaurants are facing stiff competition from two new sources – purely online delivery services & home cooks.

Online delivery services may be aggregators or actual service providers. Aggregators would assist existing restaurants to expand their footprint.  Purely online delivery services are the new kid on the block, which is today posing a threat to the traditional restaurants all over a city or atleast vast swathes of the city. They have the advantage of having their kitchen & operations in parts of the city, where rental costs are low. Unlike the restaurants, they need not setup an eatery in a prominent place, need not do up the place, spending a fortune.

The other competitor is Home Cooks! Now we can all get home cooked food instead of ordering from hotels. In Paris, it has gone one step ahead… Chefs are inviting people to their homes with the prospect of a six course meal with their family, at about one-fourth the price of such a meal in a fine-dine restaurant!

Disruption is hence everywhere. A mobile phone is all we need today. We can call, click photos, chat, search, purchase, pay bills, check mails… the list is endless. Purchases & payments are increasingly migrating to mobiles. In future, we will use our mobiles for everything else as well – from switching on the TV, checking what is happening at home sitting at office, dimming the lights or starting the washing machine an hour before one gets back home etc. This comes under the head of Internet of Things.

The coming tsunami in Financial Services - While there is so much disruption everywhere, is financial services immune from it?

No way! The disruption in financial services has just started… we have seen nothing yet!

The Robo Advisory  platforms of today are rudimentary. Today, they are asking a few questions & are suggesting a portfolio for the investor. There are others which go a bit further, gather a bit more data, do risk profiling & draw-up  a basic financial plan as well. This has led to the financial services community to derisively dismiss Robos, almost concluding that they will never be able to replace human advisors.

Machine learning, deep learning & artificial intelligence are progressing rapidly. Deep Blue, a software program by IBM, has beaten the best chess players in the world, over two decades ago. Deep Stack of Bowling’s lab, University of Alberta, has won against the best players in Poker, in the no-limits-on-bets version, very recently. This is a huge achievement as Poker is a game with lots of uncertainties & lack of information about others’ “hands”. This program can run off a gaming laptop – not a super computer! This kind of programming would have potential application across areas - from defence to medical sciences.

If such is the capability of AI, why do we think computer programs would not be able to advice competently?  Advisors would be deluding themselves if they think they are indispensible.

Yet, in conference after conference, I hear “comforting words” which imply that advisors cannot be replaced as they offer counsel , are the client’s trusted  confidante, assist them navigate turbulent waters & help them keep their cool. The “psychological counseling & hand holding” portion is being over emphasized. 

AI is advancing rapidly & soon can interpret emotions based on pupil dilation, breathing rate, flushing of the face etc. & offer expert counsel, the likes of which we will find hard to compete!

Financial Advisors need to work much harder  - Does all this then mean the death knell for advisors?

Not necessarily. Robos would attract a huge following by offering advice that is accessible to the population at large, at a small fee, be able to service a very large target audience consistently & by driving the cost to the customer down even on products suggested. As an example, Vanguard has USD 4 trillion in assets & charges an average of about 0.18%!

But, still the advisors will be there. However,  what advisors will be able to earn may come down dramatically, as the new-age Robos become mainstream, acquire human like capabilities & drive costs down – in terms of fee charged for advice, commissions from products & portfolio management fees.  

However, most in financial services field are in denial. They don’t think people will go Direct, don’t think ETFs will mainstream, don’t think robos can advise clients competently…  the  truth is that financial services landscape is going to undergo a sea change & everyone will be touched. The product distribution & advice is going to be commoditized like never before.

Product manufacturers would need to change as well - they have to respond with low cost/ high volume products & an online friendly ecosystem to suit the needs of the online advisory.

There is one thing going for the advisors. People prefer dealing with real people, instead of interacting with a computer program, however good & prescient the computer algorithm. Hence, if the advisor offers a good value proposition, they will continue to be in business.

Advisors also have to move up to the ground that Robos may not be interested in or may not be able to compete easily. There are many areas where advisors can deliver significant value to a client – life planning , major transition assistance, financial therapy, estate planning , philanthropic planning, life coach, coaching the next generation for wealth transition etc.  Advisors can well thrive if they manage this transition well and use Robos for the basics & focus on these high touch, high value areas.

Conclusion – The coming tidal wave is real. It will swamp the financial services space, as the current business model will no longer work. The high earnings on commissions & fees would go away. Financial products / services will be largely commoditized.  Advisors need to recognize these and use technology to drive down their costs of servicing customers and at the same time moving to high value areas that would add significant value to customers. Those willing to transform are the ones who will survive & thrive.  We hope that number is significant.

Article first appeared on Linkedin: The coming tech-tonic shift in financial services space!

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

Should you be investing in shares directly than through MF?

Here is a cost benefit analysis of investing in stocks directly and through mutual funds.

There would be widely varying reactions when we bring in the subject of equity. Some swear by it & can’t even begin to think of an alternative to that. Some are totally averse to equity & consider investing in equity – gambling. 

There are a whole lot of them in the middle who do not care. These people will invest in what is the flavor of the season & keep switching from one instrument to the other, based on what is doing well or what has caught the fancy of the market at that point. Only a small portion of the investors really understand investment philosophy, diversification needs, risk–reward equation, tenure, liquidity, taxation etc. These are the investors who are either savvy themselves or have advisors who are taking care of their investments on a professional basis.

Let us come to a point that seems to hold people in a thrall – Investing directly in equity is much better than investing through mutual funds. Let’s examine this premise. 

Equity investments are done directly in company shares. Equity investments are usually done by the investor himself/ herself. Most times the inputs come from their broker. They also take inputs from TV shows, papers & magazines, friends & colleagues and sundry others. Very few have subscribed to professional services or have someone knowledgeable to advice them. Mostly such investments are based on whether the stock in question is going to do well in the next 1/3/6/12 months. Many such investments are churned on a regular basis, to “realize the upsides”. Such investments are random, the logic for investment is questionable, the horizon short term & there is no diversification of any sort. There is no overarching plan with such investments – the only focus is to maximize their money – nothing else.

Sometimes investors also invest based on marquee names. For instance, they may buy stocks of Infosys, ICICI Bank, Sun Pharma etc. - here buying bluechips is an investment strategy. Such investors may keep buying such shares over time. Again, there is no strategy involved at all. One just keeps accumulating shares whenever they can and hope that they would multiply several times and make them wealthy.

Equity investment is not as easy as people tend to think – especially if they want to create long-term wealth. There are successful individual investors for sure in equity – but that number is small. Also, even out of these successful investors only some of them achieved their success through a properly thought out strategy. Others have been just lucky to have invested in some good stocks which have compensated for other bad choices & lack of a coherent investment strategy.

Mutual funds are investment vehicles tailored at those who do not want to invest their money themselves and want to take the help of a professional fund manager. The money collected for a particular scheme from many investors are invested as per the mandate of the scheme.

In this case, the investment calls are taken by the fund manager & his team. The investor himself/ herself need not get involved in deciding the underlying investments. The investors just need to clearly understand the mandate of the scheme before putting in the money – that’s all.

It is the duty of the fund manager & his team to regularly monitor the investments made – in fact, that is the only job they have. The fund manager has the knowledge , skills & experience to sift out the companies from the universe of stocks, analyse them, understand the sectoral fundamentals, tie it up with the country’s economy & the potential for the company / sector, look at external factors including global growth & geopolitical situation. Their team also has access to privileged information much more & earlier than a regular investor; they have access to the management & do have discussions directly with the top brass, to get a perspective of where the company is headed; apart from these, they have access to real time information feeds & software tools. 

Since there is also a mandate for the scheme they have to stick to, they would follow a well thought out process through which they will select the candidates. Usually, the portfolios of MF schemes are well diversified across sectors and companies, which an individual investor would find hard put to achieve. Even for a small investment an investor is getting access to the same level of diversification as the scheme! 

All these ensure that the quality of the calls taken is good and the portfolio offers a reasonably good return. The risk inherent in the portfolio is lower due to careful selection & diversification. Since the fund manager is a professional, emotions do not come in the way of the investment calls (like it normally does for investors, who get wedded to certain stocks).

Hence, the MF investor need not have to worry about their investments. They just need to check their MF portfolio maybe on a half yearly or annual basis to see if the funds are still being managed well. If there is any need for change, they can cash out & reinvest in an appropriate fund. Liquidity is assured in a MF, unlike in the case of equity – which is again a positive.

There is a cost attached to MF investing; but that would be well worth it, especially if the investor does not have the knowledge, skills & the time to do it himself. Also, investors tend to choose just a few bluechips, again and again. These would anyway be a part of many MF portfolios & there is no need to invest directly, especially where bluechips are involved. As far as the smaller company investments are concerned, the fund managers would be in a much better position to judge & take calls. Most investors burn their fingers especially with smaller stocks – they end up with penny stocks, which prove to be a lag on their investments.

For most people, MF investments are appropriate and would help them get decent returns. MFs do make it easy for investors to participate in equity markets. Only for the few who have the time, knowledge, discipline & skills in analysis would direct equity investments work. They however need to keep tabs on the companies, markets, sectors, economy & global trends & factors. That’s a tall order for most. Direct equity is for a select few. All the rest would be better served by MFs. 

Article first appeared on Money Control:
Should you be investing in shares directly than through MF?

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7

Real Estate – The Real story

Picture Credit - www.Pixabay.com

Everyone likes property. It’s tangible; it’s easy to relate to & understand; we have been buying property since the simians evolved into humans – the early properties might have been caves and dugouts!

From times immemorial, properties have been one of the treasured assets. Wars were fought to acquire territory. The only other two things for which wars were fought were women & wealth!  

Cut to the present, the war begins on servicing the EMI – for decades on end. Those who finish the loan fast display masochistic tendencies and take another loan!

The lure of property goes back to antiquity – but it’s tug is undiminished. In fact millions of people believe that property is the only one that can give great returns.  We all hear about something bought in 1960 for Rs.40,000, now going for Rs.15 Crores…  where everything is a profit, that looks stunning, eye-popping!

Fooled by absolute numbers - Rs.15 Crores is a fabulous amount of money. It has multiplied by 375 times!  It almost looks like God has picked that one person for special, A Grade treatment.

But to get to that Rs.15 Crores, one should have held on to the property for 57 years –which may happen with property and not in many other assets. But even if this has happened, the compounded annual returns are just under 11%!  Now, that does not look so appealing, does it? It no longer appears that God has showered his munificence singularly on that investor. Stock markets have offered a compounded 16%+ annual returns in the last 36 years.

We don’t count the costs… - There are so many costs in holding properties. The most important cost is the interest one would be paying. Suppose, one is buying a home today for Rs.1 Crore & one is paying Rs.25 Lakhs upfront & balance is taken as a loan for a 20 year period at 9% interest. the total repayment as EMI ( principal + interest ) would be Rs.1.62 Crores. The total cost of the home is hence Rs.1.87 Crores.

During the tenure, there are many other costs. Invariably there are repairs and improvement costs, which could run to tens of lakhs of Rupees, which we need to factor in. There are also society maintenance & property taxes, which we need to factor in as well. If all these costs are factored in, the returns may drop much lower, to single digits.

We don’t factor the efforts involved - There is not much bother in a financial asset – be it a FD, NCD, Bond, Mutual Fund or anything else. You just hold the asset & get regular returns, as per the asset type - which gets directly credited to the bank. In property, rents have to be collected, property maintained, society charges paid, interface with brokers, deal with tenants & in rare cases even be involved in litigation. Also, there are periods of vacancy that depress the returns, which needs to be factored in. Property atrophies if kept under lock & key, unlike financial assets. Hence, if property is acquired for investment purposes, one needs to consider all these as well.

Taxation on Sale - Properties when liquidated are subject to long-term capital gains tax ( after three years ). Hence, it is not that the entire proceeds are available. One needs to pay the tax and then take home the balance. In this Rs.15 Crore example, almost the entire amount will be long-term capital gain and will be taxed at 20% ( would come to Rs.3 Crores! ). To avoid this one can invest the entire Long-term capital gain amount ( which in this case is the full proceeds ) into another property. That beats the purpose of an investment in the first place, as if one has to reinvest, one cannot realize the cash value.

The albatross around the neck - Properties are high value transactions, which needs long-term servicing of loans. It is hence prudent to take loans to the extent that one can service comfortably. Many people take loans in a way that both husband & wife need to work necessarily, if they have to be able to service loans.

In such cases, it puts huge pressure & leaves no leeway for one person to drop out to raise a family or for health reasons. If there is a job loss, again there is a problem. Some have bought multiple properties & are servicing multiple loans, which builds a pressure cooker situation. 

Under-construction property can pose huge problems for people. On one hand, they may be paying rent & they may also be servicing an EMI on the property they have booked, which makes it a double whammy. Now, if the property keeps getting delayed, they would simply be paying unnecessary extra interest, on their borrowed amount. If there are multiple properties, the problems compound manifold. Some properties are stuck in litigation and takes a long time to complete. Some are stuck in limbo forever and the money is as good as gone.

Property a bane for those on the move -  Today, most upwardly mobile people would be willing to go where their career takes them. That means, they may be in Mumbai now, may move to Bangalore a couple of years down the line, or relocate to Delhi in future if their career parachutes them there. If they buy property in one city, there is a good chance that they may move to another city & stay on rent, while servicing loans of the property they have bought earlier. We have seen too many people like these. The best option for these people is to live on rent, which is available cheap in India ( read next point ).

Returns on investments – Property does not offer great returns – especially residential property – which may offer 2-3% gross returns on the current property value. After taking into account the property taxes, society charges, brokers fees, repairs, wealth tax etc., the returns are just 1-2%. Commercial properties may offer between 6-8% gross returns. But again, after accounting for all expenses, the returns may be more like 4-5%. The important error which people make is that they calculate returns on their cost & not on current price ( which is the opportunity cost ).

If you cannot sell a property, it is a FD yielding 2% returns

The menace of cash - Property transactions are prone to cash dealings. Many people who are salaried are forced to convert their tax paid money into cash for property transactions. Property is the biggest sink for black money & slush money.

While it is illegitimate & unethical to deal thus, there are more practical problems people would need to grapple with. When selling a property, there is invariably some cash which one gets. A normal person has no means to even know if the cash they get is in legitimate notes or spurious ones. If they are spurious & it is reported, a person can be arrested & questioned about the source. That will mean a lot of trouble.

Concentration Risk - Investing a couple of crores in a property is a huge concentration risk. If the area does not develop as envisaged, the property prices would not go up as anticipated. This would affect the entire investment. Had it been a financial asset, the investments can be distributed and hence one can attain diversification of the investments. If some components do not do well, it will not mar the returns from the entire portfolio.

Epilogue - Since 2011-12, the properties have not been doing well. They have been giving poor returns ( Bangalore ) in a lot of places and even negative returns in some cities ( Hyderabad ). In the past two years, property prices have come down almost across the board, all over the country. Most people who want to sell are not able to find buyers. Builders are offering various sops, which ineffect offers discounts from 5% to 20%. Apart from this, there have been actual drop in property values across properties in various locations throughout the country. Due to the base effect, property prices are expected to offer average returns ( single digits ) in the foreseeable future ( say a 10 year period ).

However, this is a great time for actual consumers who would like to buy property for self-consumption. There is a case of investing in property after investigating all aspects properly! Those wanting to invest in property should invest to diversify their wealth, not in quest of super normal returns, seeking their Eldorado! 

Article first posted on:

Linkedin : Real Estate – The Real story

Author  -   Suresh Sadagopan  | Founder | www.ladder7.co.in

#SureshSadgopan #FinancialPlanner #FinancialAdvisor #Fiduciary #LifePlanning #FeeOnly #HolisticAdvice #Ladder7