Archive for Behavioral Finance

“WHY US?”

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How should you choose a Financial Advisor / Planner?

People generally get advice from a variety of sources namely colleagues, friends, family, banks, stockbrokers, chartered accountants, insurance agents, advisors, wealth managers, and planners.

Most people today end up taking advice from several different people and hence end up with so many unnecessary and irrelevant products.

The correct approach is to create a comprehensive written strategy that would cover every aspect of personal finance for you. In short, there is a pressing need to take a holistic view of your overall situation. There should be one person or a team who takes stock of your cash flows, assets, liabilities, liquidity needs and helps you firm up your financial goals.

A lot of agents, financial distributors and banks try to call themselves financial advisors or planners. They generously also use the term financial planning / wealth management as and when it pleases them.  Consumers are naturally confused. So how does one evaluate a planner? Ask the following questions and you will have your answer.

First: How detailed and comprehensive was the data-gathering interview?

This is one of the most important steps in the financial planning process and will drive all the advice to be given. Was the data gathering comprehensive enough? Did the financial planner make notes of the information that you did not have and ask you to get back with this information? Did he take in  information about you, your family, your aspirations, dreams, goals, income, expenses, cash flows, assets, liabilities, insurance, investments, tax situation, wills, powers of attorneys and information that might be relevant? Did he ask about your behaviour towards risks and how you react in bullish and bearish situations? Did he understand the mistakes that you have committed in the past and how were they committed?

A good financial planner should take anywhere between 3-5 hours including a social chat over 1 or 2 sessions to complete this data gathering process. He will then review the data collected and revert to the client for more clarifications to make sure he has understood the overall scenario well.

This first step itself is the single biggest clue.

Second: Look closely at how the planner discusses risks and returns with you.

Does he promises you the moon and tells you how good he is and that he has provided the highest returns?

No good financial planner in his sane mind will ever do so and this is the kind of person you should look at working with. Does he take you through a proper risk profiling exercise, and tell you that the long-term return of the stock market is around 12-15 percent and therefore one should not believe theories of 30 percent returns?

Third: Don’t look at the bank brand and opt blindly for advice, as the bank is not going to advise, it is the advisor that does. Most relationship managers in banks are primarily sales people always on the lookout for selling more products to clients. They frequently change employers so a relationship manager at Bank A can tomorrow be at Bank B and then at Bank C.

Fourth: Does the financial planner take you through estate planning matters, retirement planning, different offerings, as might be suitable to you, and any other issues? He might not deal directly in any of those things but most good planners will at least give you an overview of what you need and refer you to someone competent.

Most of the private banks and distributors have a well-deserved reputation for first selling life insurance as investments and churning portfolios under the garb of financial planning.

“Would you go to a chef for a haircut, or a barber for food advice?” The problem today in the financial services industry is that you don’t know who the barber or chef is because everyone uses the same title or name. Make sure you understand the terms financial planning, wealth management and wealth manager, and that you are not just getting a lemon in the name of financial planning.

Did you find this piece helpful? We thrive on your feedback and are always eager to hear and learn from you. Look forward to your comments.

The Right Way

For quite a few years now, our team has been asking people, this question: How do you take financial decisions ??

The responses have been wide-ranging. Most people adopt a very ad-hoc approach. If they have liquidity and money in the bank, they end up buying investments from the first sales-person walking in to sell a product. What they do not realize is that adhoc actions will only lead to random results. Others research the ‘product’ that they are thinking of buying and think that they are doing the right thing. But even they have got it wrong. » Read more..

The Big 5 Money Questions- How well can you answer them ?

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We are all looking to build a financial masterpiece for our lives. Things may not be perfect today, but perfection is what we are all in pursuit of. But where do we start, and how do we get ahead? Questions are the answers.

In his best-selling book The Behavior Gap, Carl Richards defines a framework using the ’5 big questions’ to plan your financial masterpiece. » Read more..

Slow And Steady Capital

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All of us grew up reading and thoroughly believing the moral of the ‘Hare & Tortoise’ story. But then we all grew up and ‘life’ happened. Sadly, ‘Slow and Steady’ soon got replaced by ‘Fast and Crazy’ as the new winning mantra.

For the past 50 years, Fast Food has taken the world by storm – and literally so. This, despite the obvious ill effects. It is therefore refreshing to note how the “Slow Food” movement has caught on and also that slow food is the new good food.Promoted as an alternative to fast food, it strives to preserve traditional and regional cuisine and encourages farming of plants, seeds and livestock characteristic of the local ecosystem… (Wikipedia) » Read more..

PERCEPTION v/s REALITY

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Of all the ‘laymen’ explanations on inflation that I have read over the years, this has been the most interesting. In a 2008 article, master investor, Ajit Dayal, explains inflation in simple samosa terms.

In 1980, it probably cost you Re 1 to buy one samosa. Today, it costs you Rs 10. Has the samosa become 10 times larger over the past 27 years? Not at all. The fact is that Indian rupee has lost value over the past 27 years so the samosawallah wants more of your rupee to sell you the same samosa.
He wants 10 times the rupees for that same samosa. Or look at the price of your house. In 1980, it cost Rs 200 to buy one square foot of property in Cuffe Parade, Bombay. Today, it costs Rs. 40,000 per square foot. That is an increase of 200 times! Money, obviously, buys less these days. Paper money has lost value. That is what is called “inflation”.
Inflation is the blind spot, that causes most investment accidents. It is the costly overlook due to which investors often miss the mark. By a mile. Consider this. All planning and budgeting have a very long-term outlook: be it college education for our kids, retirement allocation for you and your spouse, or planning for contingency health-care expenses. They will occur many years in the future. All the more reason to constantly and correctly adjust for inflation.
Some investors forget to adjust for inflation – probably in the hope of the perpetuity 1-rupee Samosa offer. Others take an arbitrary estimate of inflation, while most use the government released inflation numbers (WPI / CPI, etc.)
The point is also that the rate of inflation for a particular commodity / service, cannot be an arbitrary number. For example think about the following in terms of their costs today compared to 10-years ago:
  1. A vacation abroad ?? Leisure inflation – anywhere around 15-20%
  2. A movie ticket ?? Entertainment inflation – anywhere around 16-18%
  3. A knee-replacement procedure ?? Healthcare inflation - anywhere around      12-15%
  4. An MBA Degree ?? Education inflation – upwards of 10-12%
  5. The cost of Petrol !!! Fuel inflation – upwards of 8-10% and so on …
Now if you were applying an arbitrary number of say a 7.72% (some WPI data) you can see how far off would you be if any of the above (the knee-replacement as a medical contingency goal, of-course) was a long-term goal. Since your guess is as good as mine, the idea is to improve the guessing process.
As Carl Richards (behaviorgap.com) writes:
For almost every other financial goal that is years away, it’s important to understand that things will change. No matter how much time we spend creating a plan it can’t capture everything about our future reality. All we’re trying to do is make the best guess we can and move on. If you understand that these are guesses (very important guesses), then you can give yourself permission to not obsess over them. Make the best guess you can with the information you have, and then commit to revisit it often enough to make course corrections long before you veer too far off course.
The other wonderful thing that will happen is that often we find out that even though our perception of our future financial needs was not even close to reality, we gain a sense of control that helps us focus on living our lives NOW. In many cases, we learn that we do have enough money and time to meet our goals. It might not even be a situation of needing to grit our teeth and save more, but we never know until we take the time to plan!
So the idea for the month is to keep your eye on the cost of the samosa (being a foodie I know I am risking ridicule by saying this but so be it).
  • Plan and put down your goals on a piece of paper.
  • Get obsessed with your goals.
  • Keep a hawkish eye on the cost of your goal year on year.
  • Be agile and course correct so that there are no nasty surprises when the goals do come up.
Did you find this piece helpful? We thrive on your feedback and are always eager to hear and learn from you. Look forward to your comments.
Team MFA

Buy Low | Sell High = Dumb

“Buy Low – Sell High.”
 
Is one investment advice which is: Clichéd, Misunderstood, Abused.
 
Abused. Because I can quote reams of data and statistic on how investors behave quite the opposite. Be it any asset class, be it any corner of the world, investors pump in money when the market tops and push the panic button and exit when it tanks. 
 
Abused. Because it says low – yet we wait for lowest. It says high – and we wait for highest. Timing the market is typical bad investor behavior. A Behavior Gap.
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We met a prospective Client last week, who was anxious and indecisive. “I am too worried to take any decision right now. The markets are too volatile. Let’s wait for markets to ‘clear up’ and then go ahead with things.”
 
But what does cleared up mean? Does it mean when people are less fearful? Does it mean when the news reports are positive? Does it mean when our friends are investing again?
 
Keeping all of these signs in mind, do you you think the market will move higher or lower when things clear up? » Read more..

What Modern Day Investors can Learn from Ulysses ‘BeesWax in Your Ears’ Strategy

Think about this pattern for a minute.
At the top of the market we can’t buy fast enough.
About three years later at the bottom, we can’t sell fast enough.
And we repeat that over and over until we’re broke.
No wonder most people are unsatisfied with their investing experience.
- Carl Richards (The Behavior Gap)

Greed / Buy - Fear / Sell © www.behaviorgap.com

Greed / Buy – Fear / Sell © www.behaviorgap.com

The problem is to recognize that, in aggregate, investors tend to be very bad at timing the market. The other problem is that though we recognize this as self-destructive behavior, we will still fall prey to the proverbial ‘Siren Call.’

So whats the solution?

Professor Shlomo Benartzi (UCLA; of the ‘Saving for tomorrow, tomorrow‘ TED video fame – dont miss the part where he says – “Self-control is not a problem in the future. It’s only a problem now when the chocolate is next to us”) has a very simple yet powerful antidote to remedy this age-old behavioral short-coming.

He calls upon investors to make an Ulyssesan Contract: a decision made in the present to bind oneself to a particular course of action in the future. » Read more..

Goals v/s Everything Else

Reaching Your Goals

Reaching Your Goals – for more of Carl’s insightful sketches on Behavioral Finance visit www.behaviorgap.com

Begin with the “WHY?”

Ask yourself these questions:  Why are you earning, why are you saving, why are you investing??

I highly doubt you said, “So I can beat the SENSEX.”

What you probably said was something like, “So I can send my kids to college,” or “So I can retire early,” or “So I can take a trip around the world.”

And yet some investors’ actions seem to suggest they’re focused on something else: beating the market. » Read more..

The Sensex has reached 20,000 now what?

Don’t we all just love Carl Richards !!

As an expert in the field of Financial Planning, Carl has done a huge favor to the entire investor fraternity by simplifying a knotty (yet crucial) subject: Behavioral Finance and turned it into powerful, simple to understand ‘Napkin Sketches’ in his best-selling book:

The Behavior Gap

The sophistication of his work is in its Simplicity. You have to read it to believe it.

Here, we bring to you a small piece authored by him. We have Indianised the content to make sure that you do not miss the message. We are sure, Carl won’t mind that.

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http://store.behaviorgap.com/long-term-wealth/

Adapted from the original article: Does 14,000 Actually Mean Anything? » Read more..

Behavioural Finance

Behavioural Finance

Most people often devote rather waste a lot of time finding the next big investment , hot stock , fund , real estate and so on. However the most important thing that impacts every family’s overall financial well being is the area of behavioural finance. This is often a neglected area by most people. Behavioural Finance is the study of how emotions and psychology affect financial decisions.

Much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process. We all know that this is never the case and human emotions and psychology play a big role in any financial decision making process.

According to Gary Belsky and Thomas Gilovich, authors of a fantastic book, Why Smart People Make Big Money Mistakes And How To Correct Them, “Behavioural Finance or Behavioural Economics combines the twin disciplines of psychology and economics to explain why and how people make seemingly irrational or illogical decisions when they spend, invest, save and borrow money.” » Read more..