We all have a choice when it comes to financial literacy. We can choose to be financially ignorant. Being so makes us very likeable to bankers, mutual fund distributors, insurance agents and other sellers of financial products. Being financially literate makes these folks keep their distance from you. They value your privacy and do not knock at your door with aggression.
Today, I see the younger generation earning far more than I ever did. I see them spending like I never did. I also see them being misled by their friends who chose to join the BFSI sector, without much effort. Of course, those in the BFSI sector are there to make their living. The friendly banker, when he is talking to you, is figuring out how to extract the most ‘revenue’ out of you, to meet his sales targets. The periodic freebies, the movie tickets and the cocktails are to make sure that you do not spend that time in acquiring financial literacy and repose your trust in the friendly young banker who goes all out to ‘help’ you. When he has his interests at heart, part of it is contributed by your loss of ‘interest’ on your money, one way or the other.
You spend a lot of time and energy earning your money. You put away money so that when you stop earning, the savings and investment pool will generate that income. Now, if you are not careful about how you save and invest, you may not get the best return from your money.
The high earner is usually a highly educated person. However, his lack of financial literacy makes him an easy kill for the BFSI sales person. Very often, the sales guy will make a pitch and keep saying, “Of course, sir, you do not need an explanation, sure you know all this” regularly. Your pride will stop you from issuing a denial and you just part with your money.
On the way to getting yourself some knowledge in matters of money, there are some (like we can only save if we spend less than what we earn) which are obvious but some (will a deep discount bond be better than a regular coupon bond) that flummox even many financial advisors. So do not lose heart. Since it is your money, it makes sense for you to spend time and effort learning about how money works.
What to learn
Once you decide to acquire financial literacy, you may find the variety of topics you need to learn about overwhelming. A good way to tackle this is to create a checklist of subjects to learn about. The following could be a good checklist.
Before getting to product choices, there are two big questions to ask yourself.
- What proportion of money do I invest in each asset class? This is linked to - Do I need the specific sum of money in one month? one year? five years?
- What is my default psychological state? (Nervous, Anxious, Concerned, Active, Worrying or Relaxed)
Once you decide to take the plunge, there is enough material available on the internet today.
But why you should become financially literate has more to do with being at peace with your money rather than trying and squeezing the last bit of return from it. While understanding returns may come easily to most folks, evaluating the hidden risks in an investment option does not. These are some types of risks you need to be aware of.
The money you invest or lend to someone, depends on that person’s ability to repay at the time agreed. When you deposit money with a bank, you are taking a call that at maturity, the bank will be solvent enough to repay your deposit. Remember, the only investments with zero credit risk are the currency note and central government guaranteed debt. While risk attached to the return of your principal is called credit risk in debt investments, such risks may exist in other products too.
The investment you have made, can you call it back at will? Or do you have to wait till a specific date? Is it readily saleable? For example, you may have a fabulous plot of land. However, there is no guarantee that you can sell it whenever you want at a reasonable price.
There is no assurance that something you bought today will fetch you a better price in future. Price risk is the likelihood of the price falling and the extent to which it can fall.
So armed with this understanding of risks, you’ll be in a better position to ask the most important question to that distributor, advisor or agent who comes to you and tries to sell you something – that’s about the return versus risks. In some investments, you can lose part of your principal, in some you can lose everything. In some, you may not lose any part of your principal. And the returns for each category will be varying. You may know or not know the rate of return at the point of investment. There can be a fixed or an ‘expected’ rate of return.
What to ask
So if you think that giving away money when your friendly Relationship Manager (what a wonderful term, this), presents you with an option without any worry or risks, think again. His ‘relationship’ with you is based on the objective of extracting the most earnings from you to meet his targets.
Also remember that the investment choice you make ties you to a minimum investment horizon. It is certain that during the life of your investment, you will see many RMs. No one holds your hands till maturity. The person who sold you the insurance policy may die before you. Or he may change homes. Or he may give up the business. And you could be in a different city. Once you have signed up for an insurance policy through an agent, his annuity is guaranteed (commissions flow from each instalment of premium you pay) whether he gives you any service or vanishes into the blue. He is your friend until the first premium is paid. After that, it is your headache.
I would urge you to keep a simple checklist handy with you. Make sure you can fill in the answer to every question in this checklist before you can consider any investment proposal from a Relationship Manager or any intermediary who is selling you any financial product.
- Do I understand the nature of the investment? If no, then I will not make it.
- Who is taking my money? Is it a bank? Insurance company? A company? A mutual fund? Is it government owned? Is it privately owned? Have I heard about the company? Is it a regulated and a listed company? Does a google review throw up anything interesting that can help me form an opinion of it?
- What is the documentation? Will there be a paper contract? Where can I verify the terms and conditions?
- Can I get a representative cash flow from the advisor? Dates of my payment and dates of expected receipts, with the amounts. I should put this into an excel sheet and check out the “IRR”. Basically tells me the rate of return I can expect.
- In terms of outflows, make sure everything like GST, commissions, costs etc are included. Most insurance companies will quote you a premium that will exclude GST but that’s a cost to you.
- If the adviser says the return is guaranteed, is it embedded in the contract or the document? Do not trust mere word of mouth. Read the wordings. Is it ‘expected’ returns or specified returns. If the investment does not meet the guarantee, who makes up the shortfall?
The important thing to understand is when and for how long you need to pay and when do your returns commence. And which is the company that will give you the money back. These are basic things we need to know. Most investments will be either in the form of equity (price risk and the risk of the underlying company performance etc) or debt (dependent on the company that is going to borrow and be responsible for repayment) or a mix of both. Sometimes, you could also be shown ‘derivatives’ – for example, you give a NBFC a certain amount of money. You will be offered a rate of return based on some external thing, like the Nifty index or the price of fish. Unless you understand these completely, do not venture. You have to understand a product so much that you should be able to explain it to someone else. If you cannot do that, you have not understood the product.
Do not be shy about asking questions. It is your money. Many advisors will bank on your ego and your hesitation to display your ignorance. When it comes to investing, pride definitely comes before a fall.