Author of 'Aspirational Investor' and President of Euclidean Capital, Dr. Ashvin Chhabra talks to Cafemutual on the sidelines of CFA India Investment Conference 2016 held in Mumbai recently. He says that people can become wealthy either by building a business or creating a human capital by investing in themselves. Read more.
What inspired you to write your book 'Aspirational Investor'?
When I was in JP Morgan Wealth Management in 1999 during the first internet bubble, I saw lots of entrepreneurs succeed and others fail. I started thinking about the advice given to these entrepreneurs. In some cases, if they followed diversification they wouldn’t have become wealthy. In other cases, they would have actually saved money. So I was thinking about what is the correct advice. The modern portfolio theory (MPT) talks about diversified portfolio. But people are actually looking for two things – safety and to build on what they do. So it is very important to make sure that we provide safety and an opportunity to pursue aspirations. Finally, I thought market portfolio provided neither. This eventually led to taking goals (the purpose of money) very seriously. This has led to the development of goal based investing which is very popular now. You cannot do goal based investing without defining a very clear framework for implementation which involves going beyond market. The other part was to create a new portfolio called aspirational portfolio which involves concentration and leverage. This is what I have captured in my book.
In your book, you have stressed the need for investing based on goals. Do you see many investors using this approach now?
Yes, at least in the U.S.A we have seen a big shift towards goal based investing, especially after 2008. Advisors have realized that markets can be unstable. But people are actually struggling to execute goal based plans. They have understood its importance and value proportion but the industry has to redefine itself to provide the right kind of solutions because you need to control risk and return to achieve goals.
You have said that diversification will not be enough to guarantee safety or to create wealth. In this uncertainty, how does one go about achieving goals?
You have to clearly define your goals and understand your cash flows. If your cash flows don’t work out no amount of asset allocation will help you. You need to save certain percentage of your income. You have to be not greedy and not fearful also. Take one goal at a time and understand the best practices of the market. Try to be a contrarian investor – invest when the market is down. If you have to build wealth, you have to either have a business or some human capital which is valuable. You have to learn to amplify that and manage risk.
Tell us more about your wealth allocation framework for individual investors…
The wealth allocation framework has two very important components. The first one is that it has goal based framework of which the market is just one part. The second big innovation is the concept of three portfolios (safety, market linked portfolio and aspirational portfolio) with specific purposes in mind. This concept is called risk allocation (how much you need in these three buckets) and asset allocation the sub-set.
What according to you is investors’ worst enemy?
Investor’s worst enemy often turns out to be themselves because they expect high returns. I think the industry can do a much better job in how it conducts itself and making sure that they educate investors. People should be educated that it is very hard to beat the markets. If you beat the market by small margin, it won’t make much difference in your life. If you want to beat the market by a wide margin, then you must understand that it is a low probability event.
Financial products are typically not designed keeping in mind the goals of investors. Do you see the need for products to be more goal oriented?
The early products that I have seen in U.S.A were target date funds which change the asset allocation according to pre-determined targets. One of the problems with such funds is that if you pre-determine the asset allocation then they are not sensitive to what market is doing. So you may be moving from equities to bonds based on when you want the money but actually you could be selling equities at an all-time low. So such products may not necessarily work.
How can investors get wealthy?
Invest in yourself. It is the biggest thing you can do. Wealth creation is done by building a successful business – by being a surgeon or a doctor and taking yourself to the next level and leveraging that. So when you become better than everybody else in a certain area, there’s a human capital. Then you build an ecosystem around you that depends on you and you get rewarded for that. So investing in yourself will make you wealthy. Building a long term business with integrity will give you higher returns than a short term business meant to maximize profits.
How can the wealthy make sure they remain wealthy?
Once you have accumulated wealth, you have to go back and find your goals. There is no need to jeopardize your safety, which is why it becomes very important to have a safety bucket. Safety comes in two forms - short term and long term (by diversifying market portfolio). You have to make sure that you have enough liquidity so that you are not selling your business at the wrong time just because you have a liquidity crunch. These two things will ensure that the rich remain wealthy. Then they can have another piece of wealth in aspirational bucket either by continuing in that area or taking those lessons and pass them to the next generation. You can take that risk capital and create a new level of wealth. My favorite example is Mr. Azim Premji because his father created his wealth very differently than he did.
Many advisers recommend funds looking at their past performance but there is no guarantee that they will sustain the past performance. In such a scenario, how should advisers go about choosing the best mutual fund for clients?
In the end, you are choosing fund managers. You choose managers with integrity and those who stick to their discipline and fund’s objective. The detriment to performance is asset flows. When funds become successful they become asset gathering machines and the performance suffers. You must understand how you achieved the past performance. You should try not to make mistakes. Don’t get greedy. Also, mutual funds should charge fee based on their performance. So advisors should keep these things in mind before recommending a fund.
Do you think too much market information is bad for investors?
The average investor should not be looking at markets. They should be looking at what they do in life and invest in themselves. Whatever be your profession, try to be better at that. Make sure your family is well taken care of. Leave the markets to professionals.
Do you think it is a good idea to follow market gurus?
You can allocate capital to somebody and let them do their job. You will always lag and underperform if you follow somebody else’s portfolio. They have a different risk tolerance than you. They are making decisions based on their goals and risk tolerance. By copying them you are almost guaranteed to be disappointed. But you can learn from market gurus. You can learn their good principles.
Which is your favorite book and why would you recommend it to others?
I like to read the entire spectrum of books in finance. Each book has something to say. I like Poor Charlie’s Almanack. It has very interesting lessons. The best books in investing are not about investing. The best book for average investor is about good common sense principles applied to investing.
