Returns, returns, returns! Seldom do customers look at other aspects of an investment product. But, returns alone cannot be used to judge an investment.
In recent times, capital guaranteed insurance products have become very popular. Investors are choosing these regular fixed return products due to the guaranteed returns on the sum assured. Some investors asked for my opinion, and were very disappointed when they learned that the product has been giving only 4.5-5 percent returns over long-term periods and not the 7-8 percent that they had actually been promised. I even had an investor trying to convince me that this was a great product to invest, simply because there was a capital guarantee and it was from a prominent insurance company and was being sold by one of the biggest banks in India. In fact, the investor also mentioned that there are some great life insurance benefits! Incidentally, the investor is 65 years old and, being an ultra HNI, does not need insurance.
Ask before you invest
The first question to ask yourself while investing is about how the product works and if you need the features the product provides. Second, what is the cost associated with the investment? Third, how are the returns generated. Regarding returns, how is it possible for an insurance company to give a fixed return of 8 percent when a nationalised bank fixed deposit gives only 5.5-6 percent annually? Either the investment must have higher risks, or something may not right with the return calculation.
Obviously, most customers find it difficult to work out actual returns. It is not very difficult and this can be done on an Excel spreadsheet using the XIRR function. There are many online tutorials available on XIRR calculation. Returns are always dependent on cash flows and, hence, in any insurance product, the sum assured really doesn't matter, if you invest in it for returns and not for the insurance cover. Do not blindly go by the insurance illustrations, as they do not include GST as well as premium loading. While doing calculations, always consider post-tax returns.
The success of the Muthoot NCD only shows us that investors tend to ignore risk in the face of high guaranteed returns. Fourth and most important, investors need to understand the risks associated. NCDs have concentration risk. If an issuing company defaults, the investor could lose the entire capital. Even with secured debentures, banks and financial institutions rank higher in the priority list for payments.
Pushing inappropriate products
My banker has been trying for the past many months make me invest in debt funds. With interest rates at rock bottom levels, debt funds face interest rate risk. While I am able to have a critical discussion with the RM, I doubt most other investors would be able to do so. Hence, the fifth question before investing is about the reason that the product is being suggested, the expected volatility and the trigger for exit. This will make the duration of the investment clear. Investors like schemes that have a defined maturity, but the same does not hold good for mutual funds and hence investors in these products need to keep in mind as to what the trigger for exit would be. These things are typically not explained by wealth managers.
Six, rankings and regulatory oversight are good for any scheme. Gold schemes from jewellers, digital gold, cryptocurrency are not regulated and some market-linked debentures may not be ranked. These are important sanity checks but they do not shield you from volatility.
Finally, if the sales pitch of the investment is for a select few or for a limited time, it is a red flag. Anything too good to be true does not work.
Benjamin Graham said rightly “the essence of investment management is the management of risks and not the management of returns.”
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