The following article was published in ‘Moneylife’ online (click here for the article on-line)
SEBI has just come out with draft regulations for investment advisors. Unfortunately, the proposed regulations will be of little consequence. It will mean little to investors and mis-selling may continue as before and with appropriate disclosures! An analysis of the proposed rules…
Investment advisor regulations have been discussed on and off for the past five years. In 2007, the Securities and Exchange Board of India (SEBI) published a consultative paper on “Regulation of Investment Advisors”. In 2008, the Swarup Committee re-examined the issue and submitted its report in 2009. The report was revolutionary in its thinking prescribing all financial products have to become “no load”. Opposition to this report was vociferous. After much heat and dust, including dharnas and morchas by a section of soon-going-to-be-affected persons, the report was buried deeply and quietly. In September 2011, SEBI published another concept paper on the regulation of investment advisors, which led to much debate. And now, in September 2012 the draft regulation on investment advisors in India has come out. How significant are these draft rules? Will it change the way people buy and sell financial products? Will conflict-of-interest be reduced?
SEBI’s concept paper had explained passionately the causes of conflict-of-interest, lamenting lack of financial literacy “in a country like India” and uselessness of disclosures when investors are financially illiterate. The concept paper proposed to set the things right by portraying work qualifications such as Chartered Accountants and Master in Business Administration-Finance as free from conflict-of-interest. SEBI highlighted the low level of financial literacy in India and the consequences thereof. It also mentioned about inherent conflict-of-interest in the prevailing agent-cum-advisor model of business practice. The concept paper advocated very strongly, the setting up of a Self-Regulatory Organisation (SRO) to regulate investment advisors. This writer participated in the debate actively and sent detailed comments to SEBI. The draft regulations appear to be a skeleton of what the concept paper set out to achieve. Here are some facts that come out:
SEBI has avoided turf war by restricting the licensing requirements of securities products, excluding insurance, real estate, commodities and pension products. If you look at any upper middle-class household, a chunk of savings is compulsory through employment (provident fund and superannuation fund). Next, big commitment is towards house purchase/construction and this area is not going to be covered through this regulation. What finally gets covered is a very small part of the savings—investing in riskier assets. So, on a weighted average basis, the effect of this regulation on a typical upper middle-class household is minimal.
The regulation appears to be enabling and not disabling. No one is going to be affected negatively and they may continue to do what they are doing. However, this negates the very object of the regulation—that of removal of conflict-of-interest involved in financial advisory and product sales—as the focus is very narrow and limited to the act of giving advice.
Most of the clearly identifiable conflicted practices are left untouched. So this regulation is not applicable to a host of financial service providers such as stockbrokers, mutual fund advisors, pension advisors, insurance agents or brokers. It is also excludes advice givers who are advising in good faith, free of cost.
In a complete turnaround, this regulation now tries to remove the conflict-of-interest through a mere disclosure. Look at the following wording: An Investment Advisor shall try to avoid conflicts of interest, and when they cannot be avoided, should ensure that appropriate disclosures are made to the clients and that the clients are fairly treated.
In another major effort at watering down, an investment advisor may have the cake and eat it too. Just read this provision—“An investment advisor shall disclose all consideration and rewards that it will receive if the client chooses the recommended security or investment.”
Financial planners, fund managers who are employees of mutual funds and asset management companies (AMCs) and alternative investment funds (AIF) are covered under the regulation. Entities other than an individual have to set up “Separately Identifiable Department or Division”. It is not a “Chinese Wall” but only an internal department or division.
Qualification of advisors now also includes post-graduate degrees or diplomas in most of the related areas such as finance, accounting and so on. Certification requirement is expanded to include “CERTIFIED FINANCIAL PLANNER” awarded by Financial Planning Standards Board India. A two-year time is also given to obtain these certifications including the one offered by NISM.
Capital adequacy for body corporate is set at Rs25 lakh and Rs5 lakh for individuals. Young professionals may feel the entry barrier is high. It would be advisable if the capital adequacy is waived off for individuals.
Registration fee is a steep Rs10,000 for individuals and Rs100,000 for body corporate for a period of five years. This will hurt many two-person dejure body corporates created by husband-wife, father-son, friends and relatives, which then work as de facto individual-run organisations.
Till such time an SRO is set up, SEBI will handle the licensing process. Does it have the bandwidth for this?
Who will be afraid of this regulation? None, because this regulation does not stop any of the existing practices, with perhaps financial planners being the only exception.
There is a saying in my mother tongue which when loosely translated means that “one caught a small rat after digging a big hill”. I have the same sense about this draft regulation. The list of excluded services is much longer than the included ones. If these provisions are gazetted as they are, the regulation would remove none of the existing conflicts-of-interest. Body corporates would be glad that they can now have one more vertical to attract investors—a mere “separate department” and ‘disclosure’ is sufficient to run the racket.
Not being a super-regulator, SEBI has restricted the applicability of this regulation only to a small sub-set of existing players and clearly precluded any future turf-wars. At the end, all are happy continuing to do what they are doing at present. From intention of the concept paper to the draft regulations, a lot of regulatory zeal has evaporated.
Those who are practicing as fee-only financial planners/advisors would be moderately elated to realise that they now have a regulatory framework to lean on. But they will be frustrated after knowing the costs involved in complying with the regulation in toto. They will not have any ‘exclusive’ tag as other so-called conflicted entities can also be investment advisors.
In other words, entities with conflicts-of-interest would be very happy to know that life can continue as usual and in fact may get even better with an additional label to sport—“Investment Advisor”. After discarding the disclosure route in the concept paper, the regulation now requires mere disclosures to comply with.
What Is Good In This Regulation?
Young graduates and post graduates whose hands are not yet bloody with legacy products and practices can think of setting up a free-of-conflict profession (from the regulatory point of view). However, this enthusiasm may yet be dampened with socialist era provision such as “Investment Advisors may charge fee subject to the ceiling specified by the Board, if any”. Even the existing conflicted service providers/intermediaries can think of redeeming themselves by complying with the provisions in letter and spirit.
How Can an Investor Benefit?
My experience says that there are as many mis-buyers as there are victims of mis-selling. Pass-backs even when banned are demanded and received gleefully. There are investors who are well-versed about minutest options in their pads, pods and tablets but not their investments. The gap between general literacy and financial literacy is too wide for one advisor’s lifetime to bridge. Investor Protection Fund, instead of diminishing in size, is increasing. The existing IPF corpus is good enough to start at least half a dozen good universities in India.
Given the economics of becoming an investment advisor, what category of investors would benefit from this regulation is a question that will be answered by the behaviour of the investors. An investor who is willing pay separately for advice is the intended beneficiary of this regulation. How many such investors are there is anyone’s guess. I am not cynical though because there are small yet growing numbers of people who are willing to entrust their financial future to someone such as a “CERTIFIED FINANCIAL PLANNER”. They do trust but also test. They would be pleased with this regulation for sure.
Am I Happy To Become An Investment Advisor?
Answer is yes and no. As a “CERTIFIED FINANCIAL PLANNER”, I comply with fiduciary responsibilities at much higher levels. But now to do it, I have to incur more cost and this is a negative. On the positive side, I have regulatory backing and can be regulatory-proud, if I can present as such to my clients. One thing, however, I am much pleased to notice is Annexure E—Comments. I am seeing for the first time that the regulator has listed down comments/feedback received in a summary format. Though it not on par with the efforts of countries such as UK and Australia, it is a good beginning. Also, Indian investors or a small set of them can be proud of the fact that they are now either on par or ahead of many developed countries when engaging an investment advisor.
I keep facing this question especially from prospective clients. They are interested to know how long the document is. Would it have graphics, tables and formulas? Is it created using a software programme or done using an Excel Worksheet? Is it delivered as a printed document or a softcopy? The message to us is clear.
If it is a financial plan, it should be a document.
While we understand the need to have something tangible in one’s hand, we would politely beg to differ. For us, Financial Plan is not the name of ‘a’ document. It is actually name of the entire process. It should be experienced and should not be limited to few pages of a document.
We may engage with our clients through various modes of communication, written and oral, being the most important. We create many documents using many formats such as MS Word, MS Excel, MS PowerPoint, MS Publisher, PDF and so on. We may use telephones, Skype and other tools to communicate with clients. We may hold a meeting, conference or seminar. We may send: emails – with softcopies attached, printed material, CDs, pen drive and so on.
So, to make the experience better to our clients and make it easy for them to understand their plan and start using it, we use multimedia approach. That is the reason we do not want to equate the financial plan to ‘a’ document. Most importantly, we strongly believe that the financial plan is after all ‘personal’ and hence no two plans would look the same. So this is our invitation for the clients to experience rather than just read the financial plan.
Mutual funds are good instruments to put your money in. Many investors know this and use it to their advantage. Some investors, however, consistently do not succeed when they use mutual funds as financial instruments. Out of my experience, I can list few important reasons why some people fail when they use mutual funds. If you are the one who has lost money consistently in mutual funds, take heed of the following
Not Knowing The Difference Between Saving And Investing
Both these financial activities are different from one another in their intent and purpose, time horizon, choice of instruments and risk and reward equation. If you confuse one to another, you end up with wrong instruments and consequently lose money. Talk to your financial planner to understand whether your goal is a savings goal or investment goal and choose the funds accordingly.
Not Understanding The Nature Of Underlying Assets
Can you compare oranges and apples? Only to the extent that they both are fruits. Both fruits are vastly different genetically. Orange is citrus and Apple is a rose fruit. Similarly, not all mutual funds are same. They differ from one another in their investment objectives. Since you are putting your hard earned money in to a mutual fund, take some time to talk to your financial planner and understand the objectives of the funds. It would be good for you if you spend at least as much time in knowing the fund you are going to put your hard earned money in as you spend on let us say selecting vegetables in the supermarket.
Looking Through The Tax Exemption Prism
Tax exemption is good to get but it should not be the sole purpose of your investment objective. Tax exemption comes with the constraint of lock-in. This means, tax planning schemes of mutual funds, popularly known as ELSS, are inflexible till they are locked-in. If you chose to invest through Systematic Investment Plan (SIP) in such schemes, the period of inflexibility increases because each instalment of SIP would have 3-year lock in. During the lock-in period, you will be just staring at the valuation, either negative or positive, with no option to take any action. If you are investing in tax exemption schemes, adjust your time horizon suitably and have good patience. Stock market is neither in your control and nor at the control of your financial planner. Only way to beat the stock market is to have patience in abundance.
Driving Looking At Rear View Mirror
Past performance is a good indicator but not the sole indicator. Don’t override the choice of your financial planner because you track the fund rankings through free websites or bloggers’ dens. Please remember the publicly available information about a fund is stale and expired. One of the most important value your financial planner can add is the information culled during the interaction she has with the fund house/fund manager regularly. No blogger or ranking website can provide you this. Most of the good financial planners and investment advisors can pick up the phone and talk to the fund managers directly.
Mutual Funds Are Not Shares
It is not an amusement to a financial planner, in spite of spending enough time with the planned, the fact that she is unable to germinate the thought that mutual funds are specialised instruments designed to invest in various types of assets including shares and stocks and are not in themselves that. Mutual Funds are not the instruments to trade but to save or invest. Mutual funds are driven by investment objectives as stated in offer documents and not meant for maximising the profits to promoters or shareholders of the companies in which they invest.
Oranges And Apples Are Fruits But All Fruits Are Not Apples And Oranges
Mutual funds are not ‘only’ about shares and stocks. They are also about cash and other types of assets/financial instruments. You can create a vast array of choices using various combinations of different types of funds to meet your goals and needs. For this to happen, you have to spend enough time and energy either yourself or with your financial planner. Your goals and needs should drive the choice of funds and not the other way round. Chase four or five stars blindly and when the day dawns there are none left except the only one.
Choosing The Wrong Time
You can call this as the curse on individual investors, especially the unguided. Money is highly emotional subject and your basic emotions sway your decision making process. You invest at market highs and exit at lows. Fear and Greed rule the roost. If you are of this mindset, my dear friend, mutual funds are not the best choice for you.
Whether you are salaried person, employed by a Government or private entity, a professional, a business person or anyone who have indulged in active pursuit of goals, take care not to fall in to the trap of adventure seeking.
a) Do not take an about turn in your career. If you had been an office goer for the last three decades, it would be necessary for the right combination of luck and hard work to become a successful farmer after you retire.
b) Do not take any aggressive stance on your investment portfolio for reasons such as starting late or mid-way losses. Economic environment may not favour your thoughts and you will not have any time left to recover from the losses.
c) Do not get in to the itch of ‘one last time before I retire’ syndrome, especially in relation to risky options in the areas of investments or adventurous activities.
d) Do not under-estimate your life expectancy. Disciplined way of living clubbed with improvement in health sciences would increase your longevity.
e) Do not give away your wealth and assets to your heirs sooner than necessary.
f) Do not ignore taxes and inflation
g) Do not ignore health insurance. You need it most when you retire if you have not created a separate health care management fund.
h) Do not ignore your exercise or yoga routine. Prevention is better than cure.
i) Do not forget to remember that when you retire you do not work for others. You never retire from what you do for yourself and your love ones.
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It used to be the common refrain in the last decade that people wanted to retire early. How early? ‘May be after 45 years’ used to be the common answer. Somehow, such thinking has diminished in the new decade. Reasons could be many. Stagnation of salaries could be one of the reasons for loss of bullishness to retire early. Economic environment could also be a dampner. Whether you wish to retire early or at the legal superannuation age, you need to know and define your transition phase.
So what is transition phase and how long it should be? Transition phase is defined usually as the time period before the actual change happens and the next phase begins, from active regular employment to part time employment or transition to profession or business or complete cessation of activities related to job, such activities constitute the transition phase. The length of transition phase would depend on your approach to retirement planning. It could be just one day as in most of the cases or it could be long drawn.
What is the importance of transition phase and what actually happens in the transition phase?
Transition phase is important in the following ways:
a) You will soak in the reality that your life would alter, may be even drastically, when you retire.
b) You will start developing your hobby or passion in to useful economic activity that can sustain you emotionally and/or financially during your retirement.
c) You will cut down on your activities related to your profession or business, create backup plan and set in motion activities to handover your jobs and responsibilities to your heir-apparent.
d) You will start counting the beans and re-align your investment goals. You will also start establishing passive sources of income.
e) If you are relocating to another place or city or country you will begin the process of acclimatisation.
A financial planner would use the transition phase to re-jig the portfolio which is currently oriented towards growth to a portfolio oriented towards safety and income generation. Usually the financial planner would use a 3-year period to perform transition activities.
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The general connotation of retirement planning actually is “Accumulation and Growth Phase” and other phases are conveniently ignored but not by a professional.
This phase of retirement planning is most exciting for you and host of other solution providers especially product manufacturers whereas you must give equal importance to all the phases of retirement planning.
What makes Accumulation and Growth Phase more exciting than others? Firstly, it is the first in the order. Secondly, it is easy to visualise. Thirdly, it could be the longest phase and comparatively easier to manage than other three phases. For do-it-yourselfers it is a veritable buffet lunch of assorted financial products and solutions. For product manufacturers it is most rewarding phase by the type of products they can manufacture. In actuality, it is the easiest phase to traverse and for a financial planner it may amount to managing the risk-reward expectation of the client unless she enters in to the nexus with the client to make it more complicated than necessary.
Why many fail in this phase? I can list some of the common pitfalls you may come across in this phase:
a) Procrastination and lack of future orientation
b) Mis-understanding your ability to take risk and not giving enough time and effort to understand the activities you need to perform during this phase
c) Over-dependence on products than on solutions
d) Failing to prioritise what is most important – current consumption or future wellbeing?
The accumulation and growth phase of retirement planning can be traversed very easily provided you:
a) start early
b) talk to your financial planner and understand your money-personality and the needs
c) keep the choices simple, easily comprehensible for you and your spouse and most importantly flexible
d) have future orientation
Best wishes for a successful Phase 1 of your retirement planning.
Your retirement planning time horizon can be divided in to four major stages or phases:
a) Accumulation and Growth Phase
b) Transition Phase
c) Consumption phase
d) Transmission or ‘giving away’ phase
One fundamental question you will face is when to start ‘investing’ for your retirement. Logical answer is soon after you receive your first ‘income’ or ‘salary’. Provident fund contribution is a statutory contribution mechanism for organised work force. From your very first salary, you and your employer would start contributing in to this account. For the present, it is a tax free accumulation and growth enabling system. What about unorganised sector of employment? If you belong to this category, or otherwise also, you can open ‘Public Provident Fund’ Account and begin your contribution. This also is a tax free account to help you in the first phase retirement planning. Those of you who wish to take exposure to equities in your primary retirement account, you can look at NPS. Importantaly, before opening the account, make it a point to understand clearly how the account works and its limitations.
When you should start contributing additional amount for retirement planning? Well, the answer again is immediate, generally. There would be certain situation in your life and career when you will be unable to do this. If you want to pursue higher education or if you are a business person or a professional starting your own practice, you will be cash strapped and would be unable to commit additional resources. Work with your financial planner to chalk out an action plan to fund your retirement account optimally.
Are you past or present or future oriented? Your time perspective has a major bearing on your ability to create wealth.
According to the research done by psychologists, if you have future time perspective, you will be more successful. People with future time perspective (futures) get more education and they earn more money. Also, they spend less and save more.
Psychologist Prof. Philip Zimbardo identified several personality types in relation to time orientation. People can live in different time zones
- Past positive: you are nostalgic and think of good old days gone by
- Past negative: you are regretful about the past and think of failure, all the things that went wrong
- Present hedonistic: you live for today and seek pleasure and sensation
- Present fatalism: your life is governed by external forces and you abhor planning.
- Future: your focus is on learning rather than play. You are goal orientend and amenable for planning
- Transcendental Future: you believe life begins after the death of the mortal body
It should be no surprise to find that future oriented people tend to be wealthy because to become wealthy you can’t spend more money than you earn. In fact, you should save and invest wisely.
Here are Prof. Zimbardo’s recommended five steps toward achieving financial freedom:
(1) The present is the best time to start investing.
(2) Time in the market is more important than timing the market.
(3) Know when your time will be up; those with a long time ahead of them can afford more risky investments.
(4) You can’t time the markets.
(5) A pleasure-seeking time perspective is an expensive habit few can afford.
Simple, aren’t they?
Link to Prof. Zimbardo’s video “The Secret Power of Time.
Two headlines in today’s Economic times attracted my attention and also caused a bit of turmoil.
First one was about Govt.’s dictate to the state run life insurance company to buy public sector undertakings’ stocks and consequently them losing in value. This incident brings back the memories of UTI fiasco in 2001. Barely a decade later, it appears that Govt.’s short-sightedness and financial exigencies are pushing the insurance behemoth in to the same road. The insurer may be too big to fail but loss of confidence would hurt the organisation and the economy greatly. With court dismissing PIL on LIC’s investment practices, you and me, either as policy holders or as advisors can do little about such decisions other than feeling the despair. People who think of ‘investing’ in such schemes because of Govt. guarantee (in spite the returns being low) should pause and ponder.
Another headline is about fee of some IIMs tripling in 5 years (from Rs.4 Lakhs to Rs.1.5 Lakhs). Another Indian Middle Class dream is biting the dust! If this can happen in the case of an institution set up by Govt. of India, there will be no control over other institutions offering similar courses and education. The report says around 25% of students would get fee waiver? The rest have to bear the burden. If you are a parent aspiring that your children should aim for IIMs please take note of these numbers. Inflation is real and it can hurt you.
Following paragraphs are extracted from Napoleon Hill’s 1938 classic “Think and Grow Rich”
The imagination is literally the workshop wherein are fashioned all plans created by man. The impulse, the desire, is given shape, form, and action through the aid of the imaginative faculty of the mind.
It has been said that man can create anything which he can imagine.
Of all the ages of civilization, this is the most favorable for the development of the imagination, because it is an age of rapid change. On every hand one may contact stimuli which develop the imagination.
Through the aid of his imaginative faculty, man has discovered, and harnessed, more of Nature’s forces during the past fifty years than during the entire history of the human race, previous to that time. He has conquered the air so completely, that the birds are a poor match for him in flying. He has harnessed the ether, and made it serve as a means of instantaneous communication with any part of the world. He has analyzed, and weighed the sun at a distance of millions of miles, and has determined, through the aid of imagination, the elements of which it consists. He has discovered that his own brain is both a broadcasting, and a receiving station for the vibration of thought, and he is beginning now to learn how to make practical use of this discovery. He has increased the speed of locomotion, until he may now travel at a speed of more than three hundred miles an hour. The time will soon come when a man may breakfast in New York, and lunch in San Francisco.
Man’s only limitation, within reason, lies in his development and use of his imagination. He has not yet reached the apex of development in the use of his imaginative faculty. He has merely discovered that he has an imagination, and has commenced to use it in a very elementary way.
What he said is very much true even today. I recommend this book for all to read. You can download a free copy at http://manybooks.net/