Assess your advisor on long-term performance

If you assess your advisor on short-term returns, he will use riskier products to generate them, which could result in losses

“I know you cannot guarantee returns, but can you give me an estimate of the returns I can expect?” I get this question from many prospective clients while exploring the chances of working together.

This is such a contradiction. They know that results cannot be guaranteed but still want to press for a milestone they can use later to evaluate performance. This is much like a young player asking a sports academy head: “I know you cannot guarantee it, but how many wickets do you think I will be able to take after getting coached at your academy?”

How does the sports academy head answer that question? He is meeting the young player for the first time. He is not sure of the potential the young player has—whether he is temperamentally more suited to be a bowler or a batsman. The sports academy’s first job would be to work with the young player to assess his talent, his attributes, and to work out an appropriate game plan for him. If he is more suited to be a batsman, he should focus on amassing runs. For all one knows, the player may be better at hockey than at cricket.

Let us say that the young player’s attributes are known, and he is good at bowling. Even then the milestone should be “I want to represent my country in all three forms of the game as a fast bowler” rather than bare statistics around the number of wickets. If the player is good enough to represent the country in all three forms of cricket as a fast bowler, he will definitely take an adequate number of wickets, consistently, and at an acceptable run rate.

If short-term results are not important, then how does the young player choose a sports academy to train under? He would look at the academy’s past results. If the academy is new, he would look at the reputation of the person heading it. Most importantly, he would depend on the comfort he gets from the initial chats he has with the sports academy head or its senior staff members. If he later discovers that the sports academy is not suitable for him, or another sports academy is better suited, he can switch.

Now, move to how most investors make decisions on selecting their investment advisor. Most of them have a vague notion of what they are investing for—retirement, children’s education, marriage, etc. But they have never sat down to calculate the numbers. They just assume that if they get high returns year after year, they will be able to meet all their goals. It is like the young player seeking a tentative target of the number of wickets without a pathway to his aim of representing the country. In fact, the initial assessment by the advisor of the investor’s goals and his resources itself is an illuminating exercise for the latter.

If an investor uses many advisors—like a young player using different academies for different formats of the game—none of them will look at his larger aims. They will use riskier products to generate higher returns in the short term. If the product loses money because of the risks, the investor may move on. The advisor loses a client, but the investor loses money.

In sports, the young player who will probably have a 15-20 year playing career, is most likely to take a decision based on long-term results. Truth be told, I cannot understand why investors take such a short-term view while appointing a financial coach who will change the way they lead their lives.

The writer heads Fee Only Investment Advisers LLP, a Sebi-registered investment adviser