Financial mis-selling

Financial mis-selling is a term that is common these days to indicate selling of financial products which are not suitable for a customer. For example, when some one offers to sell a 60 year old client a 20 year money back policy, he is plainly mis-selling a product that may not be suitable for the client.

Today’s Economic Times carries this picture of how Banks try to sell Insurance policies when asked for Investment advise (other than the FD).

And Business Standard carries a article on how Insurance companies will be held liable for misleading advertisements (Link).

Have you ever given a thought as to why this happens? Blaming the Agent / Distributor / Adviser is the easy part, but what is the role of the customer in all this.

Lets move outside the domain of finance and go into a shop that sells high end electronic items. You have a need to buy one and ask the salesman out there what is the best out there.  9 out of 10 times, you can be dead sure that he will recommend you the product that gives him the maximum margin.

But generally we do not fall prey here since most of us do a lot of homework and already have a idea on what we want. But for the guy who has done nothing, the only input he has is the Salesman’s advise. When you really have no clue, its really tough to ignore the recommendation of the salesman who one hopes has a much better insight into these things.

A secondary thing you shall ask before buying is the warranty for the product to ensure that if it does not perform as its advertised to do, the product will either be serviced or replaced for free of charge. After all, you don’t want to buy a product that works at the showroom but the moment you are at your home decides that it would not work.

Lets now move back to the financial world. How many investors approach their agents / adviser after already doing a bit of homework? Agreed, finance is not a easy subject to master but when you are investing your savings, is not the trouble worth the possible returns?

The thing with finance is that other than for Fixed Deposits, there is no guarantee of returns from any other product, but our mind refuses to accept that there could be a probability that after investing for X number (X = anywhere between 1 to 50 if I go by US data), there exists this chance that the net returns will be Zero or worse, negative.

Lets take Insurance first – the reason that Endowment / money-back policies are such a hit is due to 2 factors

1. Risk is covered (even though the amount is way small compared to what we are already pitching in with) AND

2. We get our money back (and if Lucky a additional Bonus too).

In the stock market, advisers advise on buying call / put options with the bait that it could easily double / triple. I wonder why no Insurance company tries that way of advertising (only difference being you will be dead, but hey, investment yielded 10x returns)

Financial Advisers these days are coming up with plans on how you can save for Retirement / Education / Marriage by just being a systematic investor. What they don’t say is that there is no guarantee that the amount you require will be met. After all, who knows how the markets shall behave, Right?

When it comes to mis-selling, I would lay a equal amount of blame onto the client rather than blaming the guy providing such advise of 100%. After all, most clients come up with the idea that they can have their cake and eat it too.

Markets (Equity, Debt, Real Estate…) all move in cycles and while the hope is that at the end of ‘n’ years, we will be better that what we were at the start, there is no such guarantee. Worse, almost all markets in the world have at least once seen a fall greater than 60% from its peak – in our own case, following are the percentage falls from the high points

1993 – 49%

1995 / 1996 / 1998 – average of 32%

2001 – 41%

2004 / 2006 – average of 22%

2008 – 55%

2011 – 13%

All the above are based on weekly closing hence actual peak – through draw-downs will be slightly higher. But the point I am trying to make here is that investing is never a smooth ride

Unless you are ready (mentally and financially) to ride through the storm, no amount of projections of the future is going to provide you with the confidence to invest when the chips are down.

I keep hearing financial advisers claim that the reason you should go through them is because during these tough times, they hand hold the clients to ensure they stay investing. Well, the thing is not to give you a hand when you seem about to drown but to warn you that while the river at the current juncture seems calm, there is a rapid on the way and worse, there will be a precipitous drop in the future that may wipe out years of growth.

The picture below perfectly illustrates the risk that will come in your way (and after all that you may still not be able to reach the chequered flag)

Most of us spend 8 – 10 hours every day to earn our living (Salary / Profits, whatever). How much time do you think you should allocate to ensuing that the hours spend the amount earned all does not get wasted since you followed someone who showed you dreams vs following some one who showed you the hardships that is reality

Despite widespread knowledge and regulations, the Nigerian scam is still able to dupe people to part with their money and in the same way I don’t think that mis-selling is something that can end with better regulations. It can only end if people invest a fraction of their time to understand the concept of time and return better compared to the amount of time they spend to earn that money.