Opinion | The lure of maximizing returns can often become investor’s worst enemy

Investors sometimes may not be able to differentiate between good and bad advice.
The lure of maximizing returns can often become investor’s worst enemy.(Photo: iStock)
The lure of maximizing returns can often become investor’s worst enemy.(Photo: iStock)
Updated on Aug 21, 2019 09:53 PM IST
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By Jitendra Chawla

The hart (an adult male deer) was once drinking from a pool and admiring his reflection. “Ah,” said he, “where can you see such noble horns as these! I wish I had more worthy legs; it is a pity that they are so slim and slight.” At that moment, a hunter sent an arrow whistling after him. Away bounded the hart, and soon, using his nimble legs, was nearly out of sight of the hunter. But not noticing where he was going, he passed under trees with branches growing low. His antlers were caught and the hunter shot him. “Alas! alas!” cried the hart: “We often despise what is most useful to us.”

This fable tells us that what is good for us is usually unappealing. We see this everywhere. Broccoli is healthy, but not very tasty. Even while buying clothes or shoes, simple is usually comfortable. But we choose things which are high on decorativeness while compromising on utility.

Things are not very different when it comes to investing. Simple and boring options are usually the best for most investors. But they fall for the complex, obscure and exotic. Benjamin Graham said, “The investor’s chief problem—and even his worst enemy—is likely to be himself.” What he meant was—most investors do not know what is good for them. They often despise what is good and get attracted to what is not; like the hart in the Aesop’s fable—they love the antlers.

One might think a good adviser can help an investor make the right decisions. But can investors differentiate between good and bad advice? The results of a recent survey by Morningstar suggest that there’s a difference between what investors value from their advisers and what advisers believe investors value. The survey found that adviser “helping them stay in control of their emotions” as an attribute was ranked last by investors. But it is behaviour and biases that often stop investors from making good decisions.

Similarly, “Can help me maximize my returns” was ranked fourth by investors but fourteenth by advisers. The lure of maximising returns is no different from the lure of beautiful antlers. Both look attractive but can get you in trouble. A G20/OECD INFE report on adult financial literacy in G20 countries conducted in 2017, found that four in ten people did not understand diversification and only 27% of respondents were able to both calculate simple interest and recognise the added benefit of compounding over five years.

This means, most investors: a) do not understand diversification; b) do not know how compounding works; c) do not think it is important for an adviser to help them stay in control of their emotions; d) want their adviser to maximise their returns. In a nutshell, they are attracted to bad advice as it usually sounds more attractive. A bad advisor usually promises high returns, suggests complex options and concentrated portfolios—taking more risks than necessary.

A good adviser, on the other hand, would usually suggest diversified investments in simple options. He would be realistic and reasonable in his expectations, highlighting the risks involved. A bad adviser will usually be overconfident about the future and eager to predict how it will pan out. A bad advisor, in a way, makes investing sound easy.

But investing is hard. That is why a good adviser is less confident and is cautious and prudent. He will accept his limitations in not being able to predict the future and even discuss the worst that could happen. Bertrand Russell once said, “One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.” So, an investor would be better off choosing an adviser who talks of risks involved and offers simple solutions rather than one who only highlights the returns and proposes complex solutions.

Good advisers should be like teachers and coaches to their clients. They should educate clients—on what is important and why it is important—in ways that clients relate to. Use case studies, anecdotes, stories of real people. Instead of telling a client how investing systematically in a low-cost index fund is one of the best ways to invest, it is better to take a real-life example of someone who actually did it. Or telling them how investors fared when in the past they bought stocks with high expectations built-in. Like a good childhood friend, an adviser should give advice in a client’s long-term interest, even if that advice can harm the friendship. Despite an adviser’s best efforts, some clients will not be any wiser. If they do not value what the adviser brings to the table, the relationship will be a drain. Those clients are better left alone with their ‘antlers’.

Jitendra Chawla, CFA is vice president, investment solutions at a private wealth division of a multinational bank. Views expressed are personal.

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Sunday, October 24, 2021