Good Savers but Bad Investors

Traditionally our money management matters have been handled by 3 sets of people, besides ourselves

Deepali Sen, Mint 21/2/2014

source: http://www.livemint.com/Money/bESDJ6wZFUE1bVAguBecQI/Good-savers-but-bad-investors.html

All Indians are doctors just as all of us are financial planners. Well, one can safely replace “all” with “nearly all”. We improvise on generic medication when our family members are hit by minor medical ailments. Similarly, we assume that money management is mostly about choosing investment products, which, in turn, is all about tracking past performance of these products; something that can be easily done. It is common to see people following financial advice originally meant for their friends (which could have been given by an investment adviser), not halting to ponder that this advice could be pertinent to their friend but may be altogether inappropriate for oneself.

My experience suggests that while most of us set aside a decent portion from our income as savings, we put most of our money in risk-averse products. We are good savers, but not good investors. The good news is that we follow this Hindi quote in spirit, chaadar ke bahar pair nahin nikalna chahiye (stay within your means); the bad news is that we think that containing risk is the best way to grow our money. Our fixation with guaranteed returns is high, owing to which we end up earning sub-standard returns on our investments. Inflation robs more from us than our investments earn for us. The balance between risk and return is sorely lacking. It gets tough to understand that risk and returns are two sides of the same coin. At times, the biggest risk we take is the risk of sub-optimal returns.

Our financial planning matters have mostly revolved around keeping aside surplus money in a “fictitious box”. Money from this box gets used for various needs and goals as and when they come knocking at our doors. This box could contain fixed deposits (FDs), illiquid and low-return fetching insurance policies, some long-term bonds, investments in Public Provident Fund and Post Office Monthly Income Scheme, and some stocks that were considered bluechip at the time of purchase. Other than these financial assets, we would have also bought physical gold and land or residential property.

Traditionally our money management matters have been handled by three sets of people, besides ourselves. The first being the insurance agent, who is more often than not our dad’s friend or a friend’s acquaintance, followed by an investment adviser, who either works independently or is associated with a bank, and the third character is the loan processing officer.

We are obviously the most involved as we have the complete know-how of the dynamics of our cash flows, our goals and our behavioural relationship with money. However, we aren’t organized enough to have our needs listed down, quantified, prioritized and effectively matched with the respective source of funds. We are the hub to which these spokes attach.

The first person, the insurance agent suggests child plans for our kid’s education, annuity plans for our retirement, money back policies for our various goals, or maybe a unit-linked plan to capture the incumbent growth in the equity markets. These products are suggested with an eye on the concessions available under various sections of the Income-tax Act and the fact that we could be getting some chunk of money after a block of certain years. Usually we end up paying hefty premiums for illiquid and low-return products. And, with the sum assured being low, we stay under-insured.

The second character, the investment adviser, concerns herself with allocating surplus funds in various products such as stocks, mutual funds (mostly equity-oriented), bonds and FDs. If two clients approach her for planning two very different goals such as kid’s higher education five years down the road and purchase of a bigger car a year later, she is likely to suggest similar products to both of them. She is driven more by the current contest or campaign running within the firm than by the end use of the investments thus made. Also, since she does not have complete information regarding a client’s assets, liabilities, cash flows, and goals and responsibilities, her advice is blinkered and limited to her piece of mosaic without drawing a holistic picture.

The third player is the loan processing agent. She processes our income documents to let us know our maximum loan eligibility amount and more often than not we end up taking the full loan amount as per the approval. We do not stop to do an analysis on whether we are earning (on our investments) more than what we are paying as interest (on home loan). This objective assessment aside, we are keen on retaining the status quo on our investments as it is convenient to us.

The flaw with this disjointed kind of financial planning lies in the fact that these three outside characters do not meaningfully interact with each other, because of which planning is piecemeal, superficial and ends up creating pockets of inefficiencies. For example, a client of mine had an outstanding home loan of Rs.50 lakh at an interest rate of 13%, and he also had Rs.15 lakh invested in FDs of one-year tenor earning an interest of 8.5% per annum. In effect, he was paying 13% and earning 8.5% per annum, a net depletion every year.

Our life is to a large extent what we make it out to be. So let’s resolve to organize our financial lives. I firmly believe in this quote by American evangelist Billy Graham, “If a person gets his attitude towards money straight, it will help straighten out almost every other area in his life.”

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