The importance of asking the right questions in mutual fund investing

“Nivesh Ke Liye Jo Sawaal Jaroori Hai, Tumne Wo Poochha Kya?

Nivesh Ke Liye Jo Sawaal Jaroori Nahi Hai, Wo Poochha Kya??”

Translation - Did you ask necessary questions for investment?

Did you ask superfluous questions for investment??

This may sound bizarre. Why would anyone ask superfluous questions? This explains the limitations of words. Had it been narrated with proper tone and tenor; the difference would have been clearer. Now, read the 1st line with a sense of seriousness and the second in a satirical tone. You must have noticed the difference between the two lines. I shall be putting a few questions under the referred two categories; the difference would be amply discernible. I, being an MF investor, my deliberations would smack of MF biases, but these could be applicable to any investment option.

1. The necessary questions (Questions are illustrative only. There could be subjectivity as well):

i. Which asset class I am advised to invest in?

ii. What is my opportunity cost?

iii. What is the advisable time horizon of the scheme? Does this match my liquidity requirements?

iv. How has been its performance relative to its peers and benchmark?

v. How is it expected to perform in the future and why?

vi. What is the Expense Ratio of the scheme?

vii.Am I logically convinced with the help of whatever little knowledge I have?

The list may go on, but these must be checked, and question no.

vii) is a must, as this will take care of other relevant information.

2. The superfluous questions (Questions are illustrative only. There could be subjectivity as well):

i. Which is the best scheme?

ii. How much time would it take to double my money?

iii. What is the guarantee that the objective of the scheme will be achieved?

iv. How much commission does an advisor get?

v. Have you (advisor) invested in the scheme you are advising?

I am not going to delve into each question, but investors are advised to contemplate or avoid these and many more such queries before making an investment decision. However, I will dwell upon a few questions to make things clearer assuming you are asking the necessary question referred to in 1.vii).

I will take question no. 1.iii) first.

What is the advisable time horizon of the scheme? Does this match my liquidity requirements?

Each asset class has an ideal time horizon an if an investor adheres to the timelines, the probability repeat probability to get expected return is increased manifold. For example, equity as an asset class is suitable for a very long time horizon. To quote Warren Buffet, “I never attempt to make money on stock market. I buy on the assumption that they could close the market the next day and not re-open it for five years.” One of the main criteria of your selection should be liquidly-matching. The assets are available in abundance to suit your requirements. Major mismatch could be disastrous.

Let’s discuss question no. 1.v) now:

How is it expected to perform in the future and why?

Mutual Fund’s schemes return charts carry a standard disclaimer that past performance is not an indicator of future performance. Technically speaking, keeping other things equal, Good past performance may not be an indicator of good future performance and vice-versa. This may not be a gospel, but one must analyze factors responsible for good performance together with the likelihood of continuance of those factors.

Let’s take a few superfluous questions:

2.i): Which is the best scheme?

While asking this question, investors are asking for a prophecy, and a salesman (not a Financial Advisor in the true sense of the term) very easily convinces them by showing best-performing schemes based on past performances and closes the deal with gullible investors. And I would like to quote J K Galbraith in case you plan to place your bet on forecasts, let alone prophecy. “ The only function of economic forecasting is to make astrology look respectable.” The same is true for the market forecast. At best some cues can be taken from an analysis or a forecast to understand probable directions or trends.

Here one needs to understand is that ‘The Best’ is a subjective thing, and a financially savvy salesperson very easily convinces a novice investor by showing a distorted or skewed picture of the return. Returns are to be seen in association with the underlying risks. So, don’t go for the best scheme, better go for the schemes that best suit your RRP (Risk-Return Profile).

I would discuss one more superfluous question before concluding.

2. iv) How much commission does an advisor get?

Generally, it is said that it is not proper to ask the age of a woman and the income of a man. Going by this age-old adage, it may be offending if someone asks an advisor the referred question. Seldom, rebating (against the code of conduct for Mutual Fund Distributors) might be the reason behind this question.

Besides, as an investor, one has the option to go for direct investment where brokerage is not charged. But if one seeks advice from a professional, one must understand that a professional earns his livelihood out of the brokerage or advisory fee. I have already mentioned asking ‘Expense Ratio’ in the necessary questions category.

Finally, I would conclude by repeating what Einstein once said, “I have no special talent. I am only passionately curious.” My only request is to be careful in asking questions if they are necessary or superfluous.

(The writer is Senior Vice President, SBI Funds Management Ltd)

(Translation & Synopsis by, an ace Mutual Fund Investor who requested not to be named.)