Capital preservation is terribly important: Vidhu Shekhar

Learn the basics of personal finance, and make sure you are not driven by fear and greed in your investment decisions, says Vidhu Shekhar, Country Head, India, CFA Institute, in an interview with BusinessLine . Edited excerpts:

In evaluating managers, you should look for professional competency and ethical behaviour. You have to assure that the person you are hiring knows what to do and how to act. Partly, this can be done by looking at the experience of people around you; word of mouth is very important in this industry. It is not a very scientific process. But usually, you should be able to trust your judgement on finding the right manager. There are red flags that you should try to observe ― like somebody pushing products on you and always trying to sell.

Also, a lot of people do not pay attention to the impact of transaction costs on their returns. That is something one should watch out for. Ultimately, professional competency and ethical behaviour are (two factors) that need to be judged.

One needs to have a basic sense of the absolute essentials. For instance, understanding inflation and what inflation does to your savings. Also, understanding the power of compounding, and things like Ponzi schemes, i.e. get-rich-quick schemes. You need to know how to walk away from such schemes.

You also need to understand why you are saving. Basically, we talk about three things. One is your long-term financial security ― what are your goals. Two, the need to maintain the standard of living, and finally the need to leave something for your kids.

Usually, a good investment advisor teaches you these things before starting risk profiling, formulating an Investment Policy Statement and all those things. So, it is important to lay the foundation before you get into the nitty gritty of planning.

The term AI is overused and overhyped. Most of these platforms are not using AI, like how AI is defined. They simply use rule-based, heuristics-based systems which make it easy to ask a number of questions and suggest solutions based on that. If you look at the better ones, they do a fairly good job. I think, they perform a very important role, especially given the incompetency in our industry. There is a very high likelihood that if you go to a regular investment advisor, he will not have that rigour to take you through all those steps properly and get you to the right answers. So, the robo-advisory platforms probably take care of some of the mistakes that regular advisors make.

Having said that, for emotional needs, if I am filling up a questionnaire, there is a need for probing whether I am really answering the question. Good professionals will always find the right answers. So, if the choice is between somebody with lots of experience, uses analytics with a simple system, asks few questions and gives me options, I would opt for the real person. But that real person with experience is a luxury that is not available to most people. So, I guess there is room for both.

Capital preservation is terribly important. Once that is taken care of, it is all based on your situation and your goals. With time, your liabilities will increase, and at some point, you need more spending; when your kids are going to college and you need money for retirement, etc.

That is, you have a stream of liabilities coming up and you have a portfolio with uncertain returns. If the range of that uncertainty is so large that you may not be able to meet your liabilities in time, then that is not the portfolio that you would want. You want a portfolio which has a narrower range of dispersion. So, these are not ‘yes’ or ‘no’ type of questions. It is a combination of both. You have to preserve and whatever is remaining, you have to do something based on where you stand.

Globally, there are different opinions about this issue. I am in the camp that it is best to separate fees from commissions because it is very hard to make sure that the decision made is in investors’ interest in commission-based system. Incentives act at the firm level and even at the individual level.

The problem is that, we have a system right now where income (for advisors/managers) comes from commissions, and it seems (it’s) not very easy to switch to a fee-based system as there are a lot of practical implications. For instance, the UK came up with a new system, i.e. RDR (Retail Distribution Review). We did a survey on its impact. We saw that there is reduction in the availability of services. But solely from the quality of service, I think, I will go to somebody who charges me a fee and is not getting anything out of commission.

It is best to leave it to the experts. Again, you should be aware of your weaknesses. Make sure that you are not driven by fear and greed and always ask yourself the question ― am I being too greedy? These things can very easily be brought out in conversation with your advisors, and good advisors always help you see what kind of traps you may be falling into and avoid those traps. And people who are not ethical, sometimes exploit these weaknesses. As an individual investor, you need to know yourself reasonably well.

You create wealth in your profession or in your entrepreneurship. The investment management industry only helps you to preserve and grow that wealth. Wealth creation comes from taking huge risks, taking a lot of leverage, and making very concentrated bets.

So, if I get myself a government job, I know that I am not going to lose that job. But I also know that my salary is not going to grow too much. At the same time, if I become an entrepreneur, I know that the road is going to be very hard. So, I am making a choice there that this is how my wealth path is going to be.

You cannot become rich by managing your wealth unless you are in the business of trading on borrowed capital, which is a very specialised thing like running a hedge fund. That way, you can become rich (by participating in financial markets), but then that is your business and not your wealth that you are managing.

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