By Hemanth Gorur
When you pay for something, you are naturally cautious about what you are buying. However, when it comes to something offered for free, there is a risk of throwing all caution to the wind. Free investment advice may be one such area.
Recently, the Securities and Exchange Board of India (Sebi) banned all Sebi registered investment advisors (RIAs) from giving any such free trials towards investment advice. It has mandated RIAs to offer advice only after they undertake complete personalised risk profiling of the clients.
Here’s how free investment advice can hamper the investor’s prospects.
Overlooking risk profile
Each individual has a different financial outlook and different wants and needs. Free trial advisories may not factor in this individual risk taking ability, resulting in vastly different outcomes of the investment decision. For example, two colleagues in the same profession but differing by 10 years of age may have varying ability to take risk, with the younger professional able to take on more investment risk as he or she has more time to recover from any potential loss.
Similarly, two investors of the same age but in different professions may not view an investment option in the same way—a salaried professional may be open to investing in equity whereas a self-employed person may be less inclined to do so.
Focus on short-term gains
Investment advisors are well within their right to profit from their expertise. Things can go wrong, however, if this takes the form of free investment advice designed to harvest short term gains.
Free trials by way of investment advice can open up vulnerabilities for the investor in his or her portfolio. For example, if the advice includes a lesser known stock suggested for quick gains, it’s possible the investor may even buy it without any analysis, for he or she may not know any better. The best investment advice will always revolve around a disciplined, rational, and balanced approach towards investment.
Advice out of sync with the investor’s objective
When the investor’s investment objective is not factored in, free investment advice can wreak havoc on the investor’s returns. For example, the investor may state that she wants “moderate returns at moderate risk”, whereupon the advisor may suggest to invest in midcap funds without specifying which specific fund.
Returns on mid cap equity mutual funds for a 10-year period can vary from as low as 8% to as high as 16%. This means an investment of Rs 1 lakh in the asset class can register returns anywhere from a high of Rs 4.4 lakh to as low as Rs 2.1 lakh during the period.
If the investor is expecting around 12% returns but chooses a fund at the lower end of the returns spectrum, she may end up with sorely disappointing returns. So while the free trial may suggest the right asset class, investors would do well to study the asset class in detail before taking a call.
Most investment advisors follow impeccable best practices while providing investment advisory services. Still, it is in the investor’s best interests to ask questions, compare recommendations and suggestions, and do their research and analysis before investing their money.