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Stocks

Naive investors get taken for a ride

Sucheta Dalal talks about how naive investors get conned by scheming brokerages and “advisors”, who call investors and lure them to sign up through promises of quick gains.

Once a person signs on, a barrage of helpful stock tips lures him/her to trade more actively earning higher brokerage commissions for the firm. Once the initial tips pan out successfully, these clients are persuaded to hand over larger sums of money or sometimes their entire investment portfolio, including long-term shareholding, to be managed by the broker.

Others ensure that they book profits on successful transactions, issue cheques and get clients to sign confirmation letters intermittently. When the going is good and stock indices are spiralling upwards, everybody is happy. The profits vanish in every bout of violent turbulence.

Within this broad framework, there are differing degrees to which investors can be short-changed. Some brokers are known to charge 10 per cent of the mark-to-market profit, claiming to offer PMS services.

The modus operandi is: Find investors who have heard that stock markets can make you quick and rich money, and get them to part with their funds. Then, use the money to do rapid trading, sometimes turning over their portfolio many times a day, and garner a lot of brokerage. They’ll make small profits during a bull run, and lose a lot of money during a downturn.

Who’s to blame for this? Restricting brokers and advisors is ineffective – it’s better to deal with educating the people who get conned instead. Remember that if a person is naive and greedy, there will be one person who will take away his money. The lure of quick and easy money attracts fools, and fools are easily parted from their wallets.

But even these investors only complain when the going is bad. Investors are happy to accept lower-than-market returns, if the returns are positive. From an Economic Times article:

three executives working with MNC have received negative returns [compared to benchmarks] from their PMS providers (one of the Top 5) since the beginning of the current year. For the previous three months ended April 2007, PMS schemes of these executives delivered negative returns of 3%. But, they are not aware of the fact because the statement focuses on the returns generated from the time of investment, which in this case appears respectable despite the underperformance.

Surprising that investors, some of whom hold high positions in software companies, industries and even banks, don’t bother to correlate returns with the market – especially those of market wide indices. And the same investors will not consider low fee index funds which are even lesser of a hassle. Again, the PMS providers latch on to the greed that these investors display.

Greed is not bad, of course – that’s what runs our lives. But to entrust money to a PMS provider, well knowing that markets can go up and down, deserves that the stupidest investors lose their money. Verbal promises are not solace – if you can’t get someone to sign a stamp paper guaranteeing what they say, you can’t believe them, period.

If you are an investor feeling stupid that you went for such a scheme, do not despair. I have felt stupid many times; it’s a part of life. What you should do is to fix the mistake – get out of this PMS immediately. Learn about investments, drawdowns and potential risks, creating a strict investing discipline and keep track of the money you make or lose. You’ll be richer, both mentally and “walletally”.