People end up with financial products that they neither need nor are suited for
Every financial product being sold has a person behind it. And like you and me, that person too needs to earn money to live. Naturally, she/he will do everything to sell the financial product to you so that she/he can earn a living. Whether that product is suitable for you or not is ‘generally’ not the salesperson’s interest.
And that is the main problem for customers.
As a buyer of financial products, it is very important for you to understand whether it’s suitable for you or not. The seller wants to sell. So he/she may or may not be concerned about product suitability or may not state every aspect of the product.
It is for this reason that mis-selling happens. And people end up with financial products that they neither need nor are suited for.
So, here are some financial products that a majority should avoid.
These are popular traditional versions of life insurance plans, which have been pushed/sold for decades by your friendly agent, or family member. These bundled products act as investment-cum-insurance and provide tax benefits. And this is what attracts most people. But in reality, these products neither provide adequate insurance nor reasonable returns (you only get 5-6 per cent returns overall). You can read more here.
Unit linked insurance plans (ULIPs)
These also provide both insurance and investment. But unlike traditional policies, these products also invest in assets such as equities that provide better returns. So they can potentially generate better returns than traditional plans in the long run. But again, it’s best to keep insurance and investment needs separate as ULIPs do not provide good insurance coverage and returns are also slightly subdued as various charges are deducted via unit cancellations, thereby lowering returns.
Which is the better alternative? Purchase a pure term plan for insurance and invest separately for your financial goals using proper asset allocation (via Equity funds, PF, FDs, Debt funds, etc.).
That was about insurance products; now let’s look at the investment products to avoid.
Sounds surprising? By design, smaller companies are riskier investments and so are small-cap funds that invest in such companies. And even though these funds can give very good returns occasionally, they also end up with large cuts when economic conditions become unfavorable for smaller cos. So, the return fluctuations are quite large in these funds. These funds should only be invested in if you fully understand the real risks and the probability of downsides. And since most people overestimate their ability to digest negative returns, it’s best to avoid these funds.
These funds invest in a single (or related) sector or theme – banking, pharma, infra, etc. It is true that occasionally, some sectors will do very well and deliver better than broader market returns in the short term. But this won’t happen every year. And no one can predict which sector will do best the next year or the year after. So stick to well-diversified funds alone and avoid taking sectoral bets.
PMS (Portfolio Management Scheme)
The minimum requirement for PMS investment is Rs 25 lakh. But that doesn’t mean that if you have Rs 30-35 lakh, you put Rs 25 lakh in a PMS. These are concentrated-bet products that aim for high returns by taking (at times) very large risks. Sometimes this strategy works and, other times, it blows up in the face and leads to a large loss of capital. These products are best suited for large investors who can allocate a small percentage of their overall portfolio to these high-risk schemes.
What is the alternative then? While investing in equity funds, stick to well-diversified large-cap and/or multi-cap schemes for a major part of your equity portfolio.
Debt Funds other than Liquid, Low, Ultra-Short, Short, Money-market
After SEBI’s re-categorization exercise in 2018, there are now almost 15-20 debt funds categories. But for most people, it’s better to stick to just liquid, ultra-short, short duration and money market funds. These have low interest rate risk and if picked well, can also have low credit risk. Most of the other categories have longer tenures (and hence interest rate risk) and some like credit risk funds have, by definition, risk-taking strategies not suitable for common people. Point is, when investing in debt, better play it safe and simple. For risk-taking in pursuit of return maximization, equity is already there, so why take risk in debt and lose sleep?
High-return NCDs/Deposits from unreliable entities
Yes, you want to maximize returns. When a bank FD gives 6-7 per cent and an NCD/ Deposit from XYZ offers a mouth-watering 9-10 per cent, it sure sounds attractive to you. But remember, the high returns being offered are to compensate for the high risk you take by giving XYZ your hard-earned money. And many of these high-interest-yielding products come from not-so-reliable companies which may fail to repay you in bad times. So, you risk your capital for that additional 2-3 percentage points returns. Is it worth it? For most people it isn’t.
What is a better alternative? If nothing else, just stick to bank FDs. If you understand debt funds, then pick amongst the right debt fund categories.
The list above isn’t exhaustive. But hopefully, it does get you thinking on why you shouldn’t be saying yes to all financial products pitched to you.
And that reminds of a wise quote by Charlie Munger: “All I want to know is where I’m going to die, so I’ll never go there.” The same is the case with financial products. Know what is to be avoided and you have won half the battle.(The writer is the founder of StableInvestor.com)
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