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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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We add 3% to your annual returns

Posted by Muthu on September 29, 2016

Thanks to those of you who got back to us saying that the relationship would continue to be the same. For others too, we hope same is the case.

Some of you asked me as to what is the need to be this elaborate.

The idea is to cover all possible questions which may occur to you in the context of changing regulatory requirements.

This is in continuation of our yesterday piece on commission disclosure. We mentioned that the difference between ‘Regular’ and ‘Direct’ plan of funds is roughly between 0.6% and 0.8%. This is based on the sample check I did for the funds we recommend.

We also highlighted that the returns you see in your portfolio are after expenses, which includes our commission as well.

We’ve explained in the past that based on qualitative parameters as to what value we bring to the table. I was trying to see whether it can be quantified. I stumbled on studies done by Vanguard in this regard. There are many articles about the same. All you’ve to do is to Google ‘Vanguard Advisor Alpha’.

For those of you who may not know, Vanguard is one of the largest fund houses in the world. Though they manage both passive and active funds, they are known for passive funds or index investing. In US, since most fund managers fail to beat the index, investing in index is considered an appropriate and low cost solution. Whereas in India, majority of the funds beat the index, even after expenses. We would continue to suggest investing in actively managed funds. But we do see a time in future, when it would be better to move to passive funds. Since you’ve taken this journey with us, we would suggest course change if and when required. Looks like that is at least some years away.

Vanguard believes and it is true for USA that most fund managers don’t create alpha (returns over and above the benchmark index is called alpha); whereas advisors are able to create alpha for investors roughly to the tune of 4% per annum. Since US advisors charge 1% of assets as annual fee, the alpha after fees is 3%.

This advisor alpha is created by proper portfolio construction, asset allocation, regular rebalancing, planning for tax efficient withdrawals and behavioural coaching. Out of the 4% alpha, up to 2% is through advisor’s behavioural coaching which helps the client to stay the course.

So as an advisor we add up to 4% returns to your portfolio. We subtract around 0.6% to 0.8% due to your investing in ‘Regular’ plan instead of ‘Direct’ plan. So on a net basis; we add more than 3% to your portfolio every year.

In one of the Vanguard literature, I saw the following example.

“Consider three hypothetical investors during the period between October 9, 2007, and March 31, 2014, each starting the period with a balanced (50% equity, 50% debt) $100,000 portfolio. The investor who moved this balance to cash at the 2009 stock market bottom lost $29,000.

The investor who moved to an all-bond position at the stock market bottom lost $10,000. But the investor who stayed committed to the predetermined asset allocation, in the end, gained $41,000.

The biggest value your advisor can provide is behavioral coaching.

To sum up, your financial advisor is there to counsel you, listen to your concerns, and, essentially, guide you on the right path. Your advisor works with you to add value throughout the course of your relationship.”

To repeat, we add 4%, subtract 0.8% and on a net basis add around 3%+. So you still stand to gain even after paying us (indirectly, by investing in ‘Regular’ plan).

So our suggestion: Please stay the course.

5 Responses to “We add 3% to your annual returns”

  1. In my opinion, the commission paid/charged to the investors’ return/NAV is meaningless as long as it is “reasonable” and at the net level contribute significantly to the investor’s wealth creation.
    An American model cannot be copied here. In the last 3 years, some of the MF schemes have given more than 25% CAGR and some of the PMS have also given more than 25-28% CAGR. Which is simply unheard of in American markets.
    And therefore, the simplest thing is that if some one understands the complexity of analysing a plethora of MF schemes floating in the market and behavioural maturity to deal with market volatility, etc. , then (s)he should go it alone.
    Otherwise it makes immense sense to hand over your money to the experts who know better how to manage your money and make money out of it.
    Even otherwise also, by investing in a MF scheme, we are giving our money to MF AMC to manage our money who charge roughly 2% (without distributors commission and 2.8% with distributors commission ). When we are ready to get charged by say 2% , why not get ready to get charged say even, 2.8%.

    • Girish Sidana said

      Kamal, you seem to be over simplifying the issue. It’s not a matter of yielding to 2.8% vs 2%. There is no denial that one needs a good FA to create portfolio and help during the complete journey of investment. However, by just paying 0.8% to a broker and remain invested in a REGULAR scheme does not guarantee it. In my thinking a good FA works on upfront fee and suggests you to invest in DIRECT schemes. It is a matter of market maturity. Presently, Indian investment market is not mature enough to accept upfront fee model. Let me try to compare it to another situation. Will you like to go to a doctor who does not take fee but gets his commission from the pharma company who’s medicine he prescribes? I am sure NO. So till the time we Indians come to terms to pay upfront FA fee to create, manage, rebalance our portfolios, this issue will remain.

      • I think the point of discussion which I wanted to make and also is available from the post is “not whether to go direct or through FA” but whether the commission paid to a broker/intermediary/FA – whether paid upfront separately by the investor or in the form of commission by the AMC – is justifiable or not. As long as the commission paid is justifiable, and the investor gets a better return through advisory services, it is OK provided it is between a reasonable band and justified based upon service rendered by the FA.
        I perfectly agree that we must “learn” to pay separate fee to FA and then invest in “direct” mode.

      • wapaschalo said

        Girish well said.

  2. Girish Sidana said

    I disagree with the author on his overall conclusion of “We add 3% to your annual returns”. A better approach is to pay upfront fee to a FA. The comfort an investor gets in this approach is much higher but for the investor needs to be more educated and we are still far behind.

    I, in fact more than agree on author’s statement of “The biggest value your advisor can provide is behavioral coaching”

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