Beware of investment products that promise the moon.
A friend recently asked, “Is there some HDFC Standard Life or ICICI Prudential Insurance single-premium product that will double my money in five years?” Quite a surprising question because insurance companies, even if they are selling unit-linked insurance plans, do not offer, and definitely cannot guarantee such high returns.
So, the answer seemed rather simple. But while explaining the guidelines that insurance companies have to follow, I was stumped by this message, which read, 'Invest in LIC FD Plan. Rs 1 lakh (one time). Returns after 5 years - 224,705; 10 years - 529,515 and 15 years - 1,250,665. As per current growth rate. The plan has been extended up to 15 December.'
I showed him the message and asked him if he understood what it meant. His response, as expected from an potential investor, was, “This translates into returns of more than 15 per cent. I did not know fixed deposits (FD) could double your money in five years.”
The numbers certainly were tantalising. But the ‘tiny clause’ -- as per current growth rate -- was the operative sentence.
Double-digit returns, coupled with safety of an FD, is definitely a lure. But one should always be on the lookout for ‘conditions apply’. And it will always be there in one form or another. Every person, who has invested in FDs, would be aware that the rate of interest is clearly spelled out in advertisements. Importantly, they are never a fuction of market conditions. and would know that any FD will have a clear interest rate mentioned. The sms, which was sent to me, was cleverly crafted to hide the exact rate of return.
The big lesson to be learnt here is ‘look before you leap’. Another example of this is when investors get carried away by a new investment opportunity and fail to assess its ability to generate returns.
Recently, it was reported that Osian Art Fund's was unable to make complete payments on its maiden art fund redemption.
Investors in this fund were promised 30 per cent returns by their wealth managers. However, there were several basic questions that the investors missed like -- Is there a big market for art? How do you price art? What is the track record of the art fund? What are the costs and risks associated with an art fund? What happens if the art fund is unable to sell its inventory?
There are many other misleading messages which every investor will come across. The recent one I came across was, “Invest your money and double it in 21 days.” It is quite surprising and unfortunate that time and again, people fall for such misleading messages. It is not just the retail or affluent investor who falls for such traps. Even sophisticated and smart institutional investors fall for such garbage. This was very evident from the Bernie Madoff scandal that rocked the financial world.
So, what to do when you come across such messages and pitches?
If it is too good to be true, then 90 per cent of the time, it will not be true. So, ask some very basic questions, such as - Are these normal returns or abnormal returns? What are the risks associated with the investment?
In the FD example, ask if an FD really gives 16 per cent annual compounded returns. If yes, why is 'as per current growth rate' mentioned? What returns are other FDs giving?
You would do extremely well to just ignore the noise and sleep over it. A non-resident Indian (NRI), who wanted to double his money in one or two years, bought real estate in Dubai. When the speculative price was up 40 per cent, he invested more. Today, he cannot exit at even a 50 per cent discount. Similarly, builders in India are making pitches urging people to buy now with promises of higher returns. One must tread with caution in this space. The reality is that there is an inherent growth rate every asset can deliver. Understand the conservative returns that every asset class can give you. For instance, debt can deliver 6-9 per cent pre-tax, equity can deliver 12-15 per cent a year, gold, after a correction, can give around 8 per cent a year (generally in line with inflation but in an uncertain scenario, returns can be higher, as we have witnessed in the past couple of years) and real estate gives 8-12 per cent a year. These are broad returns over a long period of time that can be expected.
Remember the adage, 'a fool and his money are soon parted.' And don't fall for misleading messages the next time you see these. Avoiding costly mistakes is the bedrock of sound financial planning and so just avoid it.
The writer is director, My Financial Advisor