Explain the fall in NAVs and exit strategies to your customers
Identify the customers in your list who have made mutual fund or ULIP or share investment. Explain to them how to decide whether to remain invested in the MF or ULIP or share. In this article I give you a scientific way of going about it.
Of particular interest are those who have invested for old age or already in old age. What do they do with their failed investments? We cannot off-hand say stay invested nor can we say get out. You need a method to decide that question. The older the investor is, the more important to take an informed decision. It is very difficult for older persons to take investment shocks.
Investments are based on hard calculations and an intuition or judgment of the future market conditions or price movements.
An example
Suppose I had invested in a mutual fund whose NAV post market crash is Rs. 12.50. I purchased it on a the promise of an advisor who claimed that the fund will give a CAGR of 15 % p.a. Suppose I had bought the MF at 10, about 5 years ago. My return in absolute terms, after 5 years, after the market crash is, 2.50. This converts to a CAGR of 4.5% p.a.
Obviously 4.5 % is not an acceptable rate of return. Especially where the financial advisor sold the fund to you promising a return of 15 %.
What advisors will now tell the investor
Most financial advisors will now tell you that the market will rise again and you can recover your money at a good rate of return in future. At such times the standard selling point is to tell the customer that the mutual fund investment is for the long run.
This is mere hope, not analysis
This is mere hope. There is no long run in mutual find investments. There exists only the short run. The advisor while telling the customers that one can make money in the long run, has made no calculation or assessment while making this statement. No one has calculated or assessed when the prices will rise and what will be the return and in how many years. Advice without the necessary calculations and assessments is meaningless. Let us take an example of a hard calculation and the type of intuition or judgement to be employed.
When will you get your desired CAGR? – The First Calculation
Supposing the fund was bought for Rs. 10 NAV per unit, 5 years ago, on an expectation of 15 % return p.a. The NAV is currently 12.5. Suppose the investor is willing to wait for 5 more years (it is already 5 years since he or she has purchased the fund), that is a total of 10 years of investment. If one were to make a return of 15 % p.a. over these 10 years, the NAV should grow at an CAGR of 25 % p.a. approximately, for 10 years from the date of original investment. In 10 yeas from the date of the original investment the NAV should reach 31, with a CAGR of 25 %.
But NAV of Rs. 31 should be achieved in the next 5 years
But now we have only 5 years left. In these 5 years the NAV has to rise from 12.50 (toady’s NAV) to 31 (the desired NAV, 5 years later). This means that the growth in NAV should be (from now on for the next 5 years), at a CAGR of 19.6 % p.a. In case the investor wants to wait for only 3 more years and then sell off the mutual fund, the required CAGR is (for the balance of 3 years) is 34.76 % p.a.
The judgment to be made – The Next Calculation
The question to ask is will the mutual fund NAV grow at the CAGR of 19.6 % p.a. for the remaining 5 years? Will the mutual fund deliver such a CAGR?
These are the questions to ask. The answers to such questions will give you a chance to take a better decision on whether to sell or retain the mutual fund. If the assessment is that neither 19.6 % in five years nor 34.76 % in three years is possible, the best thing to do is to sell the units and recover whatever money one can from the investment. If the assessment is that the desired CAGRs can be earned, keep the investment going for the period of 3 or 5 years as the case may be.
How do you make this assessment? Some pointers
Mutual Funds do not earn a high rate year-on-year: Given that 55 % of all mutual funds earn less than 8 %, the chances of a particular mutual fund maintaining an average 19.6 CAGR every year for 5 years, is remote. Even more remote is the fund generating a CAGR of 34.76 % over a period of 3 years, year after year.
How long will the share markets be down: The assessment will also require a judgement of how long the market crash will last and how long before the market starts recovery. If the past major crash of 2008 is an indication, then we can easily write off a whole year before a reasonable recovery is possible. If this is the case the required CAGR will have to be higher than that calculated. Because, the post crash period of 5 years is now 4 years, 1 year going to further crash and stabilization.
Will the companies the MF has invested in recover fast enough: Another area where a judgement will be required is which of the industry categories will recover faster and whether the fund we are invested in has invested in those companies that are likely to recover the fastest.
Ask: Who has made these assessments?
These and many other judgments are involved. Without the calculations and without the judgments, no assessment can be made to hold on to a mutual fund or to sell it off. The question is who has made these calculations and judgments? The advisor? Or the customer? Or neither? Investments are not like playing darts blindfolded. Some one has to make a knowledgeable decision.
Educate your customers
Make it your duty to inform your customers on how to arrive at a decision on whether to stay invested in the current market situation or withdraw. Discuss this with the customers who have purchased mutual funds, with the help of the example given.
While the common investor is not equipped to make such calculations and assessments, it is the duty and obligation of the financial advisor to do so and communicate to the investor. If the advisor has not communicated the assessment based on calculations, it is best not to believe the advisor. The advisor is flying a kite with his or her customer, where the kite has been bought with the investor’s money and the advisor stands to lose nothing.
We continue to be in the business of
Selling Risks not Returns