The illusion of Control

Few days back I met a prospect who had a sizable portfolio. There was huge opportunity because the reference was very strong and I had all the ingredients to make it to the list of his advisors, but it did not happen. I would attribute this opportunity loss to maybe my own selling skills or maybe it should be left for the readers to decide.

When I met this gentleman, my first question was “what is your expectation out of your portfolio and out of your advisor?” The answer to the same set the premise of a long meeting which lasted about 3 hours. The reply was “I need minimum 15% annualized returns from my portfolio and my advisor  should help me achieve higher”.

I asked him again about his returns so far and he replied that he has been consistently getting 15% and above. On the face of it I already knew this portfolio was not coming to me and the reason will be shared further. I then asked him for his oldest investment, which he said was a scheme bought in 2003. The calculation showed 17% annualized gains since inception and it was tremendous. I almost believed it to be the number for all his portfolio, but then he shared numbers, and I started getting a bit confused.

Most of the mutual funds were shown as bought in the last 2-3 years and no records before that were available. Then I asked whats the return on the entire portfolio. He replied “should be more than 15%”. When we opened the statement it showed a C.A.G.R. of -2.68% and took him by a surprise. So many times we don’t see the relevant numbers on the portfolio statement and that’s what makes us live in the false world of illusion.

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How does it matter whether a scheme is earning 18% if the overall return is either not possible to calculate or is seriously below par. Also the fact that the above mentioned client was 96% into equity and not willing to see any downside, gives you a clear picture that what we believe is in control, actually isn’t. Just a 15-20% correction in equity will make him change his thought process.

This illusion of control has caused many investors to leave the financial products and enter other asset classes, where again they live under false beliefs about their investments. “I believe that my investments are delivering 15%” and “My C.A.G.R. calculation on my entire portfolio is 11%” are two different things. What you believe has to be supported by evidence.

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So what’s the best way to have control?

  1. I personally believe in outsourcing and there in comes the role of an Investment Advisor. He draws the correlation between risk and returns for you and constructs the portfolio based on the risk you can absorb.
  2. The burden of decision should be transferred to an advisor because various biases can restrict the investor to take the right decision. For e.g. stop loss, when to buy and when to sell, how to react to market news, when to act and when not to are all the matters which are best left to the advisor.
  3. Portfolio returns are the most important number and you should know your portfolio returns, not individual scheme performances, which to my mind is irrelevant
  4. Diversification is good, but over diversification is a killer. Further, diversification between asset class is of more relevance. Diversification within the same asset class beyond a point doesn’t change the outcome much
  5. Higher returns come with higher risk, there isn’t any shortcut
  6. Remember, the advisor  doesn’t create returns, he just manages your behavior and risk. Returns are generated by markets.

I can go on and on and still not find a fixed set of rules for investing as there aren’t. There are guidelines and which may be different for different people. Investment is a journey not a destination. You don’t make returns when you invest, you make them after you have gone through the boring cycle of staying put with your strategy.