"I should have..."

One of my clients recently came to me to complain about his portfolio. To make it clear, I did not manage his portfolio; he was transferred to me from another adviser that was moving out of Singapore. So basically, he was unhappy about this adviser. 

"Even though I had invested with him for one year, my portfolio is still down by almost $600! You know, this is really ridiculous. I should have just left everything in cash. Pfft!" (yes, he really made that sound) 

I listened to him rattle on. It is always easy to blame everything on the adviser in such cases, and this is why having a financial adviser is sometimes termed as having a psychological call option. If your portfolio makes money, you let the option remain as it is. But if you incur losses, you can exercise that option and blame your adviser for it.

Before I answered him, I looked at his portfolio. My first thought was, being down by $600 shouldn't really be a big deal, unless his portfolio was only worth a few thousand dollars. As it turned out, his portfolio was worth almost S$70,000 when he invested with the adviser, so the loss of $600 was basically less than 1%. And he had only invested for less than one year - nine months, to be exact. Another look at his trade history showed that he had sold quite a few funds from his portfolio against his adviser's advice. He said that once these funds showed a positive return, he sold them in a hurry. Which was actually a silly thing to do.

My observations are listed below.

1) Investing is not a short-term game

Investing, especially in unit trusts, is at least a medium-term game of three to five years. In the short term, markets can be very volatile, and even very low-risk unit trusts can drop in value. When you invest, you must be committed. You must be prepared to lose a portion of this in the short run. If you are going to flee or make noise once your investment goes down, you are better off not investing. If you are going to need your money in just a few months' time, you are better off investing in money market funds or short duration bond funds. Or simply leaving it in the bank.

Besides, losing 1% of your money is really considered nothing, especially when you take into account my second point below. 

2) Fees are highest in the first year

Advisers need to be remunerated too. You can't expect them to construct a portfolio for you for free. Thus, there is always an upfront fee, or establishment charge, in getting the portfolio started and going. This of course means that all else equal, the first year's performance will be the poorest. Upfront fees have been on a downward trend due to increasing competition. It used to be 5% in the past; now it is usually 2% to 3%, or sometimes even 1%. In this client's case, he was charged 2%, which was still quite reasonable. So despite his investments being down by 1%, he had actually earned back almost half his fees paid.

3) Selling off your investments without discipline

By selling off whatever investments that had a positive return, he had screwed up his portfolio's strategic allocation. For example, he sold off his Asia Pacific ex Japan equities, Asian bonds, global equities, and global emerging market equities. What remained was a portfolio that was not well diversified anymore.

4) Risk profiling

It is typical for the adviser to do a risk profiling for the client to determine suitability. And it is the client's responsibility to answer truthfully. A glance through his risk profile done by the adviser showed that the client had stated that he was all right with taking a bit of risk, and that he understood that his portfolio may drop by up to 10% in the short term. Now, however, how he was behaving was entirely the opposite. 

I explained some of the points above to him, and told him that judging from what he had said, his risk profile was actually conservative - very conservative, as a matter of fact. So I proposed that he invest in some low-risk bonds instead, and due to the ease of monitoring a portfolio of lower-risk bonds, I offered him huge discounts (87%!) in my advisory fee and even waived all upfront fees. However, he replied:

"If I move the money across to the low-risk bonds, I will be worse off as the supposed returns are much less, and I am already down over 4%. To make up the shortfall and to cover the cost of fees will take a long time, perhaps years. 

Sorry for being cynical, but after all the fees are taken into account, it seems that everyone else makes a larger cut (advisers, fund houses) than the person at the end of the chain (the client)."

(To clarify, his current portfolio was around $27,000 after selling off the funds I mentioned earlier. So his current losses as a percentage of his capital invested is less than 1%; but as a percentage of his current portfolio, it is over 4%.)

I must admit that I felt a bit incensed over his reply. It seemed that he wanted high returns and low risk, and to gain back his capital in a very short period of time. This was unreasonable and impossible. And it's not as if his adviser was charging him exorbitant rates.

He continued his lamentations.

"After hearing the same stories from others who have invested, I think having cash and property is still the safest and most valuable way of investing. So far, it would have been better to have left my money in the bank than to lose money outright. You know, if I had left my money in cash and property (in Australia), I would have earned much more!" 

I explained to him that it wasn't really apt to say that, because in hindsight, everyone is right. In hindsight, I should have invested in Thailand equities in the first quarter of 2012! I would have made around 16% in just one quarter! In hindsight, I should have sold off my Asian equities last month! It would have been at the peak! It is all too easy to say that "I should have..." or "I should not have...". 

Cash also underperforms almost every other asset class on a medium to long term basis, because it only gives the minimum risk-free rate. As for property, the danger is that it comes with huge minimum investments, which tends to distort an investor's portfolio. Property is also not a sure-win investment as he thought it was - property market crashes are very real and have happened before. Real estate is also vulnerable to government interventions; just look at the cooling measures implemented in China and Singapore recently.

I also told him honestly that a drop of 4% is almost nothing compared to many other portfolios out there, especially when you take the short time frame into account.

He still wasn't convinced, but I have done my part. I have also defended his adviser in terms of the fees charged and the portfolio constructed, and corrected his many misconceptions about investing. Ironically, such people that give financial advisers such a headache are exactly the ones that need an adviser the most.