Buying a financial product in India is a bit like an arranged marriage: you don’t know what you are getting into. And once in, divorce is a costly affair.
The matrimonial ads describe the prospective brides and grooms in detail: gori (fair), very beautiful; tall, large income, own house. And of course, a religious and pious mother. These seek to describe in 30 words attributes that aim to snare a partner for life.
Financial products are somewhat similar. The sales push aims to snare. But the similarity ends there.
Due diligence by a family then ensures that the matrimonial ad did actually mean it when it said gori and the all the rest. Of course, the religious and pious nature of the mum will only play out a year later.
Due diligence to check the validity of the mutual fund or insurance promise is constrained by the fact that the groom will be unveiled only in the future.
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The moment of truth is far away. This fact allows the financial sector to get away with misrepresentation, misselling and selling practices that can only be called criminal.
The cameraman at the weekly TV programme I do brings me his portfolio. I find three insurance covers and two high-risk mutual funds. How could a bank relationship manager sell a person a high-risk fund that soaks up money equal to almost a quarter of his annual salary? How could an insurance agent palm off a high-risk unit-linked insurance policy to a person whose financial situation does not allow him to take risk?
It’s because India has no system that makes a financial adviser responsible for his advice. He can sell a life insurance policy to a 70-year-old man and get away with it.
The capital market is regulated. Banks are regulated. Insurance is regulated (well, sort of). But the slash-and-burn types who sell these products are under no regulation. Worse, banks that sell funds and insurance products are probably the worst offenders since nobody is sure who is regulating them.
Very simple handles will work for the average buyer till India gets its regulation for financial advisors in place. A financial product is a function of aim, cost, tenure and return.
First, aim. Answer the question in one line: Why am I buying this product? Remember, a good financial product will solve just one of your problems (long-term wealth creation, child’s future, retirement, an emergency, for the family if I suddenly die).
The minute you have a product that is promising to stop just short of cooking meals for you, it’s a red flag. Bundling will always confuse you and allow the vendor to obfuscate costs so that you don’t know what you are buying and what you are paying for.
Second, what is the tenure of the product? For how long is the agent telling you to hold on to the product? If your purpose was long-term wealth creation and the agent is selling a product that you have to pay for only three years, you know something is wrong.
A long-term product that aims to build a corpus by its very nature needs to be one that needs a systematic contribution over the years of accumulation. And that would be 20-30 years.
If your aim was insurance and the product is coming with a five-year horizon, it’s bad news. You need a product that will look after your family in case you meet with an untimely death. This would mean a product that takes you till at least 55 or 60.
Third, what does the product return? This is where you take your greed, keep it in the fridge and freeze it. Find out what the current five-year bank fixed deposit (FD) rate is. Now compare what is being offered to that. If the bank FD rate is 9% and you are being offered a product that does 20%, you should wonder who is generating this kind of profit to give you such returns. An annual rate of return of about 5-7 percentage points over the bank FD rate is credible. Anything over that is baloney.
Fourth, what does this product cost? This is a tough one. There are entry, exit and on-going costs. Find out how much of your money goes to work when you invest, how much is deducted each year as management fees and other costs and what does it cost you to exit.
Insurance, with its quagmire of costs, is a tough nut to crack. Simply find out what the policy will give if returns are calculated at 10% per year. The difference between 10% and the policy’s return is the annual cost. If the agent selling the policy can’t do this for you, dump him and look for somebody who does.
Your money needs to work for you and not the agent. These four building blocks will see you through till the time that some regulation will ensure that the groom is actually earning the five-figure salary, and the bride is really gori. And the mum... oh, forget it.
Monika Halan is a certified financial planner and policy analyst in the area of financial literacy and intermediation. Your comments and personal finance queries are welcome at firstname.lastname@example.org