Recently someone jokingly told me that after seeing so many advisers and reading so many articles on papers and magazines, he thinks he can also be an investment adviser. This is what he says investment advice is: High risk, high return, low risk, and low return. But don’t put all your eggs in one basket, have a diversified portfolio. Markets will be up and down, but ride the volatility and think long term; and the returns will come. He then ends his “advice” with an illustration. When you plant a seed, you don’t dig it out all the time to check whether it is growing well right? You just water it and in time to come, the plant will grow. So likewise, stay invested. After hearing him, I don’t know whether to laugh or feel upset, because he imitated it so well. But the sad fact is, these motherhood statements are so theoretical that it doesn’t give anyone any assurances that their investments will ultimately yield fruits. If you are using a financial adviser to help you with your investments, you must expect at least the following work to be done; otherwise, he is wasting your time and money.
Understand how you want your investments to behave
The first thing before you invest your money is to determine how you want your investment to behave and we determine this by understanding your need, ability and willingness to take risk. But for this exercise to be meaningful to you, we need to quantify risk so that both you and us can measure and check it. Otherwise, it means nothing to you when we say you are a balanced investor, for example. To us, we must tell you that your investment portfolio should give you an average return of about 7.3% p.a. with your investments fluctuating between –1.5% to 16.1% for 2 out of every 3 years. This is the behaviour you want and it is our job to deliver what you want.
Create a plan to give that kind of behaviour
Once we know how you want your investments to behave, we need to use historical behaviour of different asset classes such equities, bonds, cash etc, as a teacher to understand what optimal combination (otherwise known as a portfolio) will give your investments that kind of behaviour. But to make the plan even more accurate, we need to make some forecast on what the future behaviour of these asset classes will be say, over the next 5 years. With history and forecast together with some mathematical models, the plan is then created.
Tweak the plan as and when needed
Sometimes, changes in the investment environment will present real risks that you can avoid or opportunities that you can capitalise. In this case, it would not be wise for your plan to remain unchanged for the sake of: “think long term, stay invested, ride the volatility and not to pull out the plant to check the roots” This is where your adviser should and must add value. Tweaking the plan as and when needed. After all, what use is the coach if he cannot guide his player to make tactical changes when the game demands it?
Check the behaviour of your plan frequently
From time to time (in fact, most of the time), changes in the investment environment make our assumptions and forecast inaccurate and thus your investment plan will behave in a way that you are not comfortable with. Using the same example, if your plan is giving you an average return of about 7.3% p.a. with your investments fluctuating between –7.7% to 22.3% every now and then, you should be very unhappy as you are now taking more risk and getting the same average returns. This means certain assumptions have gone wrong and your plan is not behaving in a way you want it to behave. We need to look into the cause and adjust your plan to behave properly again. We also need to check regularly that the “smart brokers” are doing their jobs well; otherwise, we need to replace them with more capable ones.
When I wrote about buying term insurance and investing the difference (though investing is not the reason for buying term insurance) in the past months, I realised a common phenomenon. Detractors to this approach often cite fears in the uncertainties of the investment world as reason for their preference in using insurance as the accumulation tool. I did not know why the lack of confidence then, but I now understand why. To be able to do what I said above, portfolios must be mathematically created using data from established financial data providers such as Bloomberg, Lipper, Standard & Poor’s etc. Instead and unfortunately, I suspect that many of the portfolios that consumers have, was created based on gut feel or in a “guesstimate” manner. That being the case, one will not know how their portfolios will behave in a specific quantifiable manner. And that means one cannot make necessary changes when things go off tangent because he does not even know what actually went wrong in the first place. Without these regular checks, how then can you be confident that the portfolio will yield the fruits that you want say, 20 years down the road?
It is true that when you plant a seed, you do not dig it out every now and then to make sure it is growing. But you check that the plant will come out after certain amount of time has passed. You check it is growing to the size that you expect it grow based on some historical statistics. Yes, you adjust it according to the current conditions. But when it is totally growing in a way that you don’t want it to grow, you make adjustments to the water, the fertiliser, the sunlight and so on. Only then can you be sure it will bear fruits in due season. You have paid your adviser whether by commissions or with a fee to take care of your financial plant. Make sure you get what you deserve.
The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-only Retirement Financial Adviser. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation. The edited version has been published in the Business Times on 9th March 2005.