Last Updated on July 15, 2020 at 10:59 am
A natural, emerging question among investors looking for professional help from a SEBI registered fee-only advisor is, “If the financial planner only recommends index funds, why should I engage with him?” We requested SEBI Registered Investment Advisor Swapnil Kendhe to explain the nature of the financial planning process and what clients are actually paying for.
About the author: Swapnil is a SEBI Registered Investment Advisor and part of my list of fee-only financial planners. You can learn more about him and his service via his website Vivektaru. In the recently conducted survey of readers working with fee-only advisers, Swapnil has received excellent feedback from clients: Are clients happy with fee-only financial advisors: Survey Results. His story: Becoming a competent & capable financial advisor: My journey so far
As a regular contributor here, he is a familiar name to regular readers. His approach to risk and returns are similar to mine, and I love the fact that he continually pushes himself to become better as you see from his articles:
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If the financial planner only recommends index funds, why should I engage with him? I detest writing anything that looks like self-promotion, but someone must take responsibility to answer this question, so let that be me.
Investors usually check performances of highest rated funds on fund comparison websites and see that all these funds have beaten index funds by a wide margin. This leads to the belief that it is easy to find funds that would beat index funds in India. No wonder they do not want to engage with financial planners who recommend index funds and refuse to recommend anything else for the equity allocation.
We will come to index funds and planners recommending index only portfolios, but before that, it is important that we understand what financial planning really is. There are misconceptions about the fundamental nature of financial planning in India. Most investors equate financial planning with investment planning. They believe that a planner’s job is to help them generate higher returns or make them rich.
While investment planning is a part of financial planning, financial planners are not in the business of helping clients generate a higher return. Their job is to help clients build a secure financial foundation for themselves and their families.
To do this, good financial planners look at a client’s entire picture, not just his investment portfolio. Planners probe and study the client’s life situation and financial situation. They help the client articulate his financial needs and objectives and establish realistic financial goals in rupee amounts and time frames.
Most investors come to financial planners with wrong ideas about investing. Good planners deconstruct client’s flawed investing style and reconstruct a better one. To do this, planners spend some time educating clients about capital market behaviour and the principles of sound money management. This is an important part of the financial planning exercise. No matter how good a plan document the financial planner prepares, if the client does not have conceptual knowledge and frame of reference to understand the plan, he will not stay disciplined and committed to it.
Planners then help clients put important financial things in place and align their savings and investments in the right direction to help them achieve their financial goals and overall financial well being. For retired clients, a financial planner’s job is to ensure that clients don’t outlive their assets.
Financial planning is a personalised service. Plans are created to match a client’s personality and predisposition to risk. The right asset allocation for a client is the one he feels comfortable with; not the one robo advisory templates recommend. You don’t recommend aggressive equity allocation to an inexperienced investor just because his time horizon is long. A Robo advisory template is only as good as the investor or adviser using it.
Financial planning is not a rigid product to be bought and consumed by investors. It is a fluid process. You create a financial plan based on your present understanding of money management. As your understanding becomes more clear and you gain better insights, your approach to financial planning also changes.
Even your financial goals are only guesses of the financial needs of your future self. The person you shall become 5, 10, 20 or 30 years hence is a stranger to you today. Your life changes. Your goals change. Therefore you have to revisit the financial plan on a regular basis and re-align it towards your current vision of ideal life. Planner and client have to work together in financial planning.
What creates confusion in financial planning is fund selection. Clients want the best performing funds. The easiest thing for a financial planner to do in this situation is to recommend the highest rated funds on fund comparison websites. No client has ever complained to a financial planner because the planner recommended him the winning funds of the recent past.
The problem with this approach is that ten years back there was a totally different set of winning funds which were rated highest on fund comparison websites. Most of these funds are underperforming index funds and their peers today. The fate of today’s highest-rated funds may not be any different.
We need winning funds of the future, not the past. Unfortunately, there are no reliable tools that can help us find these funds in advance today. Fund selection is not a science, neither it is an art. It is more luck than anything else. You can analyse the past performance of a fund all you want, but it won’t help you predict its future performance.
In a portfolio of actively managed funds, there could be funds that may beat the index but what matters is beating the index fund return at portfolio level over the long term. This is terribly difficult. There could be brief periods in which the portfolio may beat the index but remember, no life should be considered happy until it ends.
To beat the index in a client’s portfolio, a planner not only has to construct a portfolio of actively managed funds that shall beat the index in future, he must also keep his clients stay invested in such a portfolio. There are periods of underperformance even in funds that beat the index over the long term. When underperformance starts, clients lose conviction in the fund and want to leave it for better performing funds. It is extremely difficult for a planner to keep his clients invested in an actively managed fund during its period of underperformance. The planner cannot also know if the underperforming fund would ever recover and beat the index.
The combined probability of a planner constructing a portfolio of actively managed funds that beats the index fund and his clients staying put in such a portfolio over the long term is close to zero. As a financial planner, the more you think, the more you realise that it is silly to try to beat the index in a client’s portfolio.
Index investing is boring and uninspiring; but combine it with disciplined saving, asset allocation and rebalancing, and it becomes a formidable force. It makes investing simple and frees up a tremendous amount of time and energy for both the financial planner and his clients. They can use this time and energy to focus on more important things like managing asset allocation of the portfolio.
Let us now come back to the original question. Why should you engage with a planner if he only recommends index funds? Indexing is never the starting point for any investor or a financial planner. You arrive at this simplicity after spending years doing all kinds of smart-sounding stuff that doesn’t work.
If a planner recommends only index funds, then most likely he has spent some time reading and introspecting about financial planning and investing. Such a planner is also likely to have stumbled upon a few other insights about money management that you never thought about. Some of these insights can change the way you manage your money for the better.
As a retail investor, you don’t have to do anything smart. If you manage to avoid mistakes consistently over a long period of time, you end up doing better than the majority of investors who can talk and write about investing better than you. You are likely to commit fewer financial mistakes when you work with a financial planner who has intellectual humility to appreciate his own limitations and has learned to avoid distractions.
If you are reading this article, you are smart enough to learn and create your own financial plan. But that is the easier part of the process. What is difficult is sticking to the plan. You have to behave correctly over and over again. This is easier said than done. Working with a financial planner increases your chances of sticking to the plan.
You could be smarter than the financial planner, but at times emotions override the reason. A financial planner can protect you from your emotional decisions because he is an objective third party who can look at your situation unemotionally. He can stand between you and the big mistake you might commit.
You are also more likely to save more when working with a financial planner. The planner can investigate how much you decided to save towards your goals and how much you actually saved. This is enough to make you save significantly more than what you would otherwise. Saving is a bigger contributor in achieving financial goals than any other factor.
A planner who recommends index only portfolios is highly likely to be an honest adviser who knows his stuff well. Recommending an index fund portfolio is the best thing for a planner to do for his clients but not for the planner himself. Once a client enters into the engagement, the planner can help the client understand the virtue of index investing. But most investors seeking financial planning advice reject planners who say that they only recommend index funds. Only a person who has confidence in his worth as a financial planner can recommend index only portfolios.
In some advisory models such as commission-based and percentage of AUM fee model, there is a need to believe that it is important and possible to beat the index. Fixed fee-only financial planners can be more honest with themselves and their clients.
Financial planning is in its nascent stage in India. But the quality of financial planning advice on an average is steadily increasing. Planners are learning and getting better with experience. Finding a good financial planner will continue to remain hard but you can always begin with a prayer and freefincal’s list of fee-only financial planners.
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