How to value stock advice

As a benchmark, 1 per cent of your portfolio size is a reasonable limit for annual advisory fees, provided you are happy with the service.

Look for verifiable evidence of the person's records before following the advice.

Alex Frankl

Opinions, so the saying goes, are like mothers; everybody has one. Nowhere is this truer than in the stock market. What's unusual about the stock market is not just the number of opinions you come across. It is also that while some people offer advice at the drop of a hat, others demand a fortune for theirs.

Opinion vs advice

You can turn on the TV or pick up any newspaper and find good opinions on the stock market, and that's free. With so many opinions being given freely, does it make sense at all to pay for stock advice?

To answer this question, it is important to first distinguish between opinion and advice.

Opinions express a general view of a stock but often leave the most important questions unanswered: ‘What price to buy at?''; ‘‘how long before I should sell?''; and ‘‘how much can I make on it?''.

To be really useful, ‘advice' should enable you to act with the belief that you are doing what was intended by the advisor.

What to pay

So assuming you do find a talented and trustworthy advisor, how much should you pay? This is an easy question to answer in hindsight. If you followed the advice and made a profit, its value ought to be lower than (or a portion of) your profits.

If you didn't, it should have no value. Of course, this is not a useful approach, because most advisors take an upfront fee. So how much should you pay for stock advice, given that you don't know if it will turn out to be good or bad? You should consider two factors; the likelihood and the magnitude of returns.

Track record

Gauging the likelihood of success is obviously not easy with stocks, but one crucial factor you can use to evaluate an advisor is his track record. Always look for verifiable evidence of the person's results before following the advice.

This evidence could come from client referrals, from their own records or from an independent industry body. Use whatever is available to you. Paying for advice without first seeing a track record is like buying a stock without looking into the books; it's not advisable.

Okay, we all know that ‘‘past performance doesn't guarantee future performance'', but in the stock market past performance is the only guide you have.

When considering what the magnitude of success may be remember that despite the outlandish claims people make, no one gets it right all the time.

In fact, very few people beat the market by a huge margin.

A good advisor may beat the market by a few percentage points per year; he will not generate a multiple of the market return. The maximum you should be willing to pay, therefore, depends on the size of your portfolio as much as it depends on the advisors themselves.

On a Rs 1 lakh portfolio, an advisor charging Rs 1,000 a month has to beat the market by 12 per cent just to justify the fees; this would be some achievement.

However, on a Rs 1 crore portfolio, the advisor can charge Rs 10,000 a month and only have to beat the market by 1.2 per cent, clearly much less challenging.

As a benchmark, 1 per cent of your portfolio size is a reasonable limit for annual advisory fees, provided that you are happy with the service and the results delivered.