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Beware of the Advisor ‘Alpha’

Investment advisor

Investment advisor often claim that they are an Alpha, a fancy word that simply means the extra returns they can give you buy making you invest in various mutual funds and other financial products.

But often the alpha might stand for that alpha wolf waiting to pounce on the next gullible investor. As we know most of the financial intermediaries steer you to buy commission laden products. What else do they really ‘produce’?

The net return after commissions and inflation is often negative, and at best overrated. When told that direct mutual funds save about 1% or more every year which adds up to a hefty sum, they downplay it. They may tell you that the difference is only about 0.6%. This is plain bunkum.

They will also tell you that they can somehow generate an excess return (alpha) compared to other funds and the market. There is usually no basis to make such a declaration – can they share the data on other portfolios? Can they share their own portfolios – where they have actually invested?

If you do not wish to directly invest by picking stocks, then the only two options are:

1) Direct Mutual Funds and

2) Exchanged Traded Funds that mimic the index.

There is a debate raging on which is a better option.

We feel that for the next several years, Direct Mutual Funds are better – of course you will need a small help in selecting the right funds. Whoever helps you do that should not make any commissions, and charge a fee that is as low as possible.

Conclusion :

One needs to make sure that hidden costs like brokerage etc do not eat away your returns. You pay brokerage both when you buy and sell. Often the advisor has an incentive to make you ‘churn’ your portfolio in the name of ‘rebalancing’ it. Result is more brokerage. Unlike Direct Mutual Funds that carry no other costs (not even taxes after one year), ETFs will ensure a steady brokerage revenue stream for the intermediary.

So choose carefully!

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Ram Kalyan Medury

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