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Don't Buy What You Don't Understand

Okay, I’m up to here with relationship managers and financial advisors and the like. In the process of assessing a new business opportunity in providing advisory services, I have most recently seen people perplexed with the kind of investment opportunities offered.

An NRI is offered an insurance product as a long term savings avenue. The product offers Rs. 25,000 per month as a "pension", after you turn 60. The deal is that you invest Rs. 11K per month for 10 years, between the age of 40 and 60. You basically take the maturity proceeds of one product and invest it in an "annuity" product of the same insurer

The problem? If you do this in a regular long term bond fund yourself, with similar return assumptions, you can generate nearly 31,000 of income, with none of the liquidity issues with annuities, lower tax implications and potential to earn far more by allocating money to both equity and debt. And best of all, it’s simple and easy to understand, compared to the weird complex product suggested.

Another person, a non-resident, is offered the same "HDFC Crest" product I detest. The person has no use for the insurance, but was somehow convinced that he was guaranteed a 15% return on his investment. After reading my post about it, he asked me and realized there was no such guarantee. And that, indeed, the Rs. 15 guarantee from a Rs. 10 investment, over 10 years, is chicken-droppings (you could do better with savings deposits nowadays).

A PMS product offered a "30% compounded return in the last 10 years". But on probing we found that this amount was before fees, and the fee would drop the return down to 28%. Even simple funds like HDFC Equity or HDFC Top 200 (not in the top of their league, btw) have done 29%, and that is post fees. Plus, the return from these funds is not taxable; while a PMS investor might incur short-term capital gains tax if they have short term exits.

In all the cases above, it was the investors who were enamoured by the products, from the great packaging, despite the substandard nature of the product itself. The point was that it was being sold to them, they had no idea what alternatives existed, and they trusted the people who made the pitches. The combination is killer, and often misused, even by close relatives, to sell such products. After all, if you don’t know what the better alternative is, why should they tell you?

But the larger point is: they liked such products even though they didn’t really understand them and that their trust was misplaced. If a relationship manager tells you of a guaranteed return of 15%, you must demand to see it in writing in the product or on their web site. Because you simply can’t trust such people. Or anyone in the financial field at all. Secondly if they offer you a great return through a complex formula, it’s probably too good to be true.

Knowing of alternative products is near impossible for someone who is only looking to park money to get it out of their savings account and into something more productive. And the number of options, combined with the time needed to analyze them, is simply too much to handle. So while you need an independent advisor (who gets no commissions from the product) to decode and simplify, such people might be too expensive, too difficult to find or otherwise unavailable. And it’s not easy to find out who’s independent and who is not. 

With that, should you just buy when you get a "juicy" product that someone hard sells?

No.

Don’t do it. Don’t buy a product unless you understand enough of it. If you don’t have the time, don’t buy it. If it’s not simple, it’s likely to need more research, which you don’t have time for. You can use simple products like Fixed Deposits, or, if you are more comfortable with the nature of the beast, Mutual funds. The minute the word insurance comes in, run for cover.

Put another way: Buy only what you know. Don’t buy what you don’t understand.

  • Manshu says:

    The other aspect of this is that often you think you know enough but you simply don’t know what questions to ask or don’t have a feel for when things are suspicious. I have seen people who think 15% per year guaranteed is no big deal and they don’t dig deeper and get screwed.

  • Krish says:

    As a NRI, recently I tried to open the equity trading account and found documentation is cumbersome, opening fees are very high and transaction charges are steep (1% for buy or sell). Twice I have attempted to open in the last 5 yrs and could not manage it even today.
    For NRIs, currently NRE FDs rates are made at par with resident FD rates. But this has happened only last year. The tax free returns of NRE FD are at least decent which could in many cases beat bonds, balanced funds and other debt products. When this option was not there, predominantly RE was the only option for NRIs to generate decent returns. It is during that tenure, I have seen lot of NRIs fallen for complicated products that included ULIPs, Highest NAVs and so on.

  • Harish Nagpal says:

    This is what is at present happening ,people only understand FD,Gold, and Real estate and that is the largest in almost every portfolio. We( SEBI,IFA,BANKS,BROKERS) need to make an effort to make people understand the financial products .Financial Literacy is required …………….;) Wat u say deepak ?????

  • Jigam Gandhi says:

    Hi Deepak,
    I agree with you there is lot of mis- selling happening. Also Insurance guys put same money in mutual funds (ULIP) of same trustee to generate more fees. Recently India Info guy showed me returns of 15% and MY excel sheet showed 10%. On further probe , he told me that returns as based on working day ???????.
    The only advantage Insurance have over individual investments is Tax Breaks, Which is EEE, (Exempt, Exempt, Exempt). and so our effective returns are not much higher because of the TAX we have to pay. Insurance industry is only flourishing because of that. There is no flair for Optimization, it is always comparative performance.
    Hope SEBI and IRDA brings in some strigent rules.

  • Statspotting says:

    Speaking of understanding, we asked this question: how many of us really understand how money is created? For something so important, is it not strange that most of us cannot explain on a whiteboard, the process of money creation?
    http://statspotting.com/2012/12/the-irony/