I grew up in Bihar where things happened at their own sweet pace—and other than buses, trains, the traffic, the pace of life, and government files, the universities also ran late. My three-year BSc course took more than four years, ensuring that by the time I started my post-graduation I was already 23. After completing that, I worked as a research scholar and tried doing a PhD for three years, eventually dropping out, leading to a situation where I started my first job—at a now defunct newspaper—only at the age of 28. Given these wasted years, my credibility among even my immediate relatives was quite low at the time.
Within months of joining, a random incident helped build some credibility. One day—if I remember this correctly—I got a call from my mother. Her father had been sold what he thought was a lifetime-free credit card. It wasn't. It was only free for the first year. The moment the year ended, the foreign financial institution that had sold him the credit card sent him a bill, asking him to pay the fee for the coming year.
Now, he had had no use for the card, given that almost everything he and my grandmother bought was largely home-delivered and paid for in cash. So, I told my then boss about this situation. He called up someone at that financial institution and the charge was reversed, and in the process, some of my credibility was restored.
The reason I am discussing this in some detail here is because this is the first of my many memories of financial mis-selling that has happened to me and my immediate family over the years. Here are a few more stories.
Around a year down in that job, I decided to buy a term insurance policy. I understood that I really didn't need one given that I was single, had no outstanding loans, and no financial dependents. But given that my primary job was to write on personal finance I wanted to experience the system. I decided to buy a term insurance policy from the Life Insurance Corporation (LIC) of India.
The agent tried really hard to sell a unit-linked insurance plan (Ulip) of a private insurance company to me. Even though I was new in the profession of writing on money, I knew that it was best to keep one's insurance needs and one's investment commitments separate. Given that, I didn't fall for it.
Early one morning in late 2008, I was sitting all alone in the office and trying to get my writing for the day done. My landline phone suddenly rang. I was told that my relationship manager at the private sector bank I had my salary account with had come to meet me.
This was the first time I was hearing of a journalist having a relationship manager. My curiosity got the better of me and I decided to meet her.
After some random chit chat where she told me that she was from Jamshedpur and I told her that I was from Ranchi, she got to the real purpose of her visit. She wanted me to buy this Ulip that she said would double my investment in three years.
Now, this was 2008, and this strategy of selling a Ulip that would double an investment in three years was in vogue. Most prospective customers just loved the idea of an investment doubling in three years. They barely thought it through: For an investment to double in three years, it needs to generate a return of 26% per year, on average, for three years consecutively. That is highly improbable if you are investing in a broad-based investment scheme like a Ulip that, in turn, will invest in a certain number of stocks.
What the relationship manager did not know was that as the personal finance editor of the newspaper I worked for, I had already gone through the minute details of this scheme. It had something known as a premium allocation charge of 60% in the first year. Yes, 60%.
Dear reader, you read that right.
What that meant was that if an investor invested Rs 1 lakh into this Ulip, only Rs 40,000 would be invested into stocks or debt securities or a combination of the two, depending on the mandate for investment the investor chose.
Those were days when Ulip schemes operated like they were in the wild west—where the idea seemed to be to take the investor's money and scoot. So I pointed this out to her and then suddenly she started crying.
It turned out that to complete her target during the last financial year she had sold the Ulip even to her younger brother. Her brother had invested Rs 1 lakh in the Ulip. After deducting the premium allocation charge of 60%, Rs 40,000 had been invested. Then the stock market had fallen and the value of the investment was down to Rs 32,000. The brother had noticed this, not liked it, and stopped talking to her. Even after this experience, she was trying to sell me the same Ulip.
In 2009, a few months before my father was to retire, he was sold a pension plan. He was supposed to invest in the plan for the next 15 years, with the plan maturing when he turned 75. Locking up an investment for 15 years at the age of 60 wasn't the best way to go about investing. Thankfully, I came to know about it. The policy was in the free-look period of 15 days and we managed to return it.
I can go on and on with such stories. But let me end with a recent example of mis-selling that I managed to thwart. A few months ago I received a message from my father, asking me whether a newly launched small-cap mutual fund was a good investment bet.
It so turned out that the financial institution that had launched the small-cap fund wasn't a mutual fund. It was an insurance company, trying to pass off a Ulip as a mutual fund by using terminologies such as new fund offer and Rs 10 per unit, which are oft used by mutual funds. My father's question was for someone else. I asked him to suggest to them to stay away from this investment.
I have always been intrigued by mis-selling but have never gotten around to thinking about it in a systematic way. If I were to put it in a slightly different way: What's the economics of mis-selling?
1) Let's start with the simplest question first: Why do individuals who indulge in mis-selling do it in the first place? A simple answer to that would be: everyone's got to make a living—paapi pet ka sawal hai—and if I won't do it someone else will. In a country like India where the demand for formal jobs is much more than their supply, the competition that exists for such jobs encourages mis-selling.
2) While that may sound like an explanation, it really isn't. It's very simplistic. The individuals mis-selling are encouraged to mis-sell—it's a part and parcel of working in the financial services sector. They don't do it by themselves.
So why do financial institutions encourage mis-selling? Corporations are amoral. Or as Martin Wolf puts it in The Crisis of Democratic Capitalism: "[They are] institutionally incapable of recognizing the distinction between right and wrong or feeling remorse or empathy. This is not just because, being institutions, they are incapable of feeling anything. It is also because incentives encourage such amoral behaviour in those who control them."
Which is why when you go to a bank to start a fixed deposit, a relationship manager might try to sell you a Ulip, on which the bank will make a high commission. Or your local mutual fund agent might encourage you to get out of an old scheme and get into a new one, making a higher commission in the process. Or your local insurance agent—who your father has dealt with all his life—might try selling to you a traditional insurance plan, where returns will not even meet the rate of inflation. This is also why many high-net-worth individuals are sold structured products and portfolio management services, where there are higher commissions to be made.
Again, this is an easy explanation and there's more to it.
3) Now, a corporation might encourage mis-selling, but it takes a human being to carry it out. Why do relationship managers, insurance and mutual fund agents, wealth managers, stock brokers, etc., mis-sell? Again, I could say, that there are bills to be paid. But there's something more to it than just that.
Bosses who encourage mis-selling in a way know that they are going to get away with it. As Kaushik Basu writes in Reason to Be Happy—Why Logical Thinking is the Key to a Better Life: "A part of this is simply a matter of impunity. They have the ability to do things without fearing reprisal from consumers or workers, who typically do not have comparable heft." I mean nobody ever went to jail for mis-selling a financial product, but a lot of people made a lot of money doing so.
Further, as Wolf suggests, "top executives are unlikely to be held personally liable for anything". He offers the example of the global financial crisis—where the financial services industry primarily mis-sold home loans—and what happened in its aftermath: "The executives who drove their banks (and the world economy) into the ground, before the global financial crisis, mostly walked off with large fortunes, while tens of millions of innocent people's lives were ruined and governments were forced to provide huge bailouts."
For these shenanigans only one banker went to prison in the US and none in the UK. The point being that the higher-ups in financial services firms rarely face any cost for the mis-selling that they incentivise.
4) What about the worker bees? How do they rationalise mis-selling to continue sleeping well at night? Basu has an explanation: "The large and complex structure of corporations allows them to create 'guilt shelters'; that is, protect the individuals who are part of the corporation from feeling responsible and guilty for the behaviour of the corporation and the final outcome."
5) This explains the supply side of mis-selling. There is a demand side as well—individuals who become victims of financial mis-selling. And they become victims primarily because of their financial illiteracy, which leads to information asymmetry, where the side selling the product has more information about it.
In fact, if one thinks about it in more detail, financial illiteracy has a larger impact than the most obvious one. Let's say someone's main job is to sell a financial product. They train themselves well for it and decide to advise their customers accordingly. Let's say they decide to talk about the most important principle of investing—diversification within and across different kinds of investment—at a point when stock markets are going through the roof. Will their customers appreciate this?
What if they tell their customers that while the stock market in India has given a return of around 13% per year on average since 1999 (Nifty 50 TRI Index), there can be downs in an individual year or even over a few years, and given that it makes sense to work towards a corpus with the assumption of a return of 10-11% per year? Or that small-cap stocks in the past have fallen by 80% very quickly?
In order to appreciate a financially literate salesperson of financial products, the prospective customers also need to be financially literate. And the twain don't always meet. In fact, they rarely meet. Which is why it is easier to just sell an investment scheme by saying that the investment will double in three years, however improbable that is.
6) So what is the way out? First and foremost it is important to understand that the financial services space in India is very crowded—there are banks, stock brokerages, wealth management firms, non-banking finance companies, individual insurance and mutual fund agents, and now, even fintechs—all trying to sell more or less the same set of products to a small cohort of people who actually have the money to invest or the capacity to borrow and repay. (Dear Reader, if you are reading this, you probably already fall in that cohort.)
So given the competition, the sellers will do whatever it takes to sell. In that scenario, the only way to avoid this is to be financially literate. This is something that doesn't happen overnight—irrespective of what fin-fluencers might tell you.
Second, if possible, try developing a relationship with a good financial planner. Again, your ability to identify a good financial planner will depend on how financially literate you are. Also, you may have to dig wide first to be able to dig deep. The idea should be that the financial planner doesn't recommend anything to you that they won't do themselves in that particular situation. If you can't reach this stage then it's better to invest through exchange traded funds and index funds.
Third, it is important to realise that many individuals trying to mis-sell financial products are very young—in their early 20s to their early 30s. They really do not have the adequate experience of a lived life to be able to advise us on what to do with our money. Again, this realisation can only come through adequate financial literacy.
Fourth, and this has to happen at a societal level, money and the different aspects of its management need to be taught in schools and colleges. While it is important to teach children the fact that mitochondria is the powerhouse of the cell, it is also important to show them the power of compounding.
Over the years, friends have often asked me about the so-called wasted years, and what I would have done with them otherwise. The answer is simple: I would have done exactly what I did. Read some great books. Heard some terrific music on cassette tapes and Vividh Bharati. Watched some of the best masala Hindi movies ever made. Discovered cable TV as it made its way through our daily lives on dull, dreary and never-ending hot afternoons. Played cricket and watched it. And, of course, gone to college on days it was open, and also on days it was not open, and hung out with friends, made proxy calls during attendance, eaten samosas, and avoided the litti chokha.
The time well-spent in the so-called wasted years is what helps me make a living now. In the end, luckily, it all turned out well, leading me to conclude that all learning doesn't necessarily happen in a class room, some of it could have also happened at the matinee show at what used to be the Sujata Cinema in Ranchi, watching the first day first shows of everything from Govinda's Raja Babu—a movie that helps me make so much sense of modern Indian politics where politicians keep changing clothes through the day—to Shah Rukh Khan's bitter-sweet Kabhi Haan Kabhi Naa—a movie that helped me understand that one might keep trying but that doesn't mean that one will necessarily succeed. But that there is no other way out.
