Rahul, a young professional, goes to his bank to open a Fixed Deposit (FD). However, the sales executive of the bank marketed another product called ‘Super FD’. The executive said that ‘Super FD’ will give higher returns (9-9.5%) while offering all other benefits of regular FD. Rahul found the returns quite attractive and bought that ‘Super FD’ without any independent research.
A few months later, he read in the newspapers about the default of these products, called the bank’s AT1 bonds. AT1 bonds are unsecured, perpetual bonds that banks issue to increase their core capital base. Not only was Rahul’s money locked, but it was also not covered under the Deposit Insurance Act, which provides some cover on the money invested. After going through social media, he realized that he was not alone. The crowd of investors had lost their hard earned money in that product. In fact, social media is flooded with posts about investors buying such wrong products.
Such financial misselling is on the rise in line with the increasing penetration of financial products in India. This blog will discuss nine ways that investors can protect themselves from falling prey to financial misselling.
Map goals for risk and investment horizon
A major reason for attracting the wrong products to their portfolio is that most investors do not align their goals with their investment horizon and risk appetite.
For example, a financial product such as an equity mutual fund may not be suitable for investors with short investment periods. This is because equities have a tendency to be volatile in the short run. Thus, any sharp negative movement of the market can affect the short-term goals of the investor.
At times you may be tempted to invest in equity funds for short-term goals, especially during the bull market phase, by showing the attractiveness of short-term returns. Hence, you need to align your investment with your goal and not just blindly invest in any instrument.
By mapping goals to risk and investment horizon, investors will be in a better position to identify whether the financial product being marketed to them meets the broader contexts of their need, thus making better financial decisions and their portfolios. able to avoid mis-selling products. ,
Get into the habit of pre-planning investing
The January-March quarter of the financial year is the period when most investors make last-minute plans for their tax-saving investments. This is because, in a last minute rush to pay taxes, investors tend to buy any financial product sold to them, thereby saving tax. This is yet another recipe for engaging in unfairly sold financial products.
The most common example is buying life insurance endowment plans that offer an anemic return to investors while locking in their money for a long period of time. Another example is a five-year bank fixed deposit at your neighborhood bank, which, when adjusted for inflation, provides investors with modest or negative real returns.
Thus making last minute investments is not a prudent practice. This last-minute investment may result in investors having to borrow money to save tax if they do not have the required amount for such investments. Hence, investors should inculcate the habit of pre-planning their tax saving investments to avoid such hassles.
do your due diligence
Marketers, consultants and distributors will present many products to individuals through presentations, mailers and other forms of communication. However, investors should not buy a product based on this information. Investors should do their own research on products marketed as such, independently read and research before investing.
This independent research may involve asking for more supporting documentation for the claims made by the marketer in their original document. Asking the marketer the right set of questions can also give you a better understanding of the product.
For example, what is the lock-in period of the product? What are the tax implications? What are the costs involved? Furthermore, in today’s world of data and information, it is also important that investors gather information about the product by reading product information blogs, videos and reviews.
Doing this independent research leads to understanding of the product and gives better confidence to the investor. Furthermore, through these readings, investors are in an advantageous position to cross-question the product vendor regarding various nuances such as taxation, expense ratio and lock-in period, among other things.
understand the costs involved
Most investors focus on the expected end result of the investment in terms of value for money/return and ignore another equally important aspect of buying a financial product, that is, the cost of investing in the financial product.
For example, till about a few years back, while investing in products like Unit Linked Insurance Plans (ULIPs), heavy charges were levied on the investor, resulting in lowering of the actual amount invested. Some ULIPs charge more than 18% of the initial premium for these charges. So, in fact, out of Rs 1 lakh invested by an investor in the product, only Rs 82,000 is invested, thus reducing the impact on the overall return from the product. The expenses will have an impact on your final return. So, as an investor, you need to first understand the charges to be paid, recurring charges, exit charges etc.
Thus, while evaluating returns from a product, look not only at returns, but also returns after expenses.
Check Your Financial Advisor’s Creditworthiness and Remuneration
Investors have a short-sighted view of the financial product being sold with a fixation on returns. However, it is important that they also assess the creditworthiness and remuneration of the seller of the product.
The creditworthiness of the individuals can help investors understand the experience of the advisor. In addition, investors can freely engage with the seller’s existing clients to understand their experience.
It is equally important to understand the remuneration received by the marketer on the basis of product recommendations. The commission of the product may be the guiding factor for sales by the distributor and not the suitability of the product for you.
In fact, higher commission products also mean that more fees are deducted from your invested amount towards the distributor, which means lower overall returns and profits for you.
Let’s say the advisor is charging a different fee. In that case, it is necessary to conduct a cost-benefit analysis of the suggestion and compare it with the competition to get a clear picture of the financial advice being sold.
Don’t buy if you don’t understand
Investors are often inclined to buy financial products despite their lack of understanding due to investor biases such as rumors and herd mentality. It is also linked to a psychological concept today called FOMO, or the fear of missing out. The classic case is the frenzy behind investing in cryptocurrencies in recent times. Too many investors don’t understand the broad outline of crypto, let alone the details. Still, they jump to trading crypto.
Unless the product is understood correctly, investing in it is a recipe for disaster. Therefore, it is important that investors do not succumb to FOMO. Instead, they should only buy financial products they understand to avoid falling into the trap of misselling.
Understand liquidity and redemption income
Before investing in any financial product, investors should understand the liquidity and redemption proceeds from the product. This is important to know not only from the point of view of the investor but also from the point of view of their dependent in case any unforeseen circumstances result in the need for cash flows.
For example, in case of life insurance endowment plan, investors are able to get liquidity only by taking loan against the product. This is also a limited base of accumulated corpus and also hinges on regular payment of insurance premium.
Similarly other products like ULIPs have a lock-in period of 5 years while for Tax Saving Mutual Funds i.e. Equity Linked Savings Schemes (ELSS) it is 3 years. The investor should understand this lock-in period and the liquidity options available for any financial product before investing.
Understanding the liquidity and redemption part also goes hand in hand with proper placement of family members in the purchase document and providing them with the necessary information about the product and reliable advisor.
Understand Actual Returns Claimed Vs.
Many a times, investors get swayed by the high claims of the market to buy financial products. As a general rule, any financial product being marketed with claims of unusually high returns is likely to be too good to be true.
No product should be viewed in isolation from historical or projected returns; Instead, it should be viewed as a whole in relation to the risks associated with the product. It is also important to look at the cost (expenses involved) and the return of investment after taxation effect before making your investment decision. For example, a bank fixed deposit (FD) may not involve any visible cost; However, the interest is the taxable basis of the individual’s personal income tax slab. So an investor on the highest tax slab (30%) will actually get only 4.2% from FDs that pay 6% interest.
Understand the exclusions in the case of insurance policies
An insurance policy is something that investors buy to protect themselves and their loved ones from unforeseen situations. Therefore, it is important that they read the terms and conditions to avoid any loopholes/exclusions from the policy.
This exclusion scenario was in the news recently and was widely circulated on social media when a policyholder allegedly did not receive a motorbike accident claim because he was riding a bike whose engine was Carbon Combustion (CC) Capacity exceeded a specific limit document in the policy. ,
It is thus important that the investor understands all the exclusions, terms and conditions attached to the insurance policies for which he has purchased the policy, to avoid any financial calamity between himself and his family members.
The financial market in India with its multitude of products presents a viable investment opportunity for the investors. However, investors should consider carefully and diligently to make the most of this opportunity. For this it is necessary that they do not depend only on the products delivered/advised while investing; Instead, they should implement the steps mentioned in the article to avoid the pitfalls of misselling and make their investment journey more fruitful.