Good, bad and ugly of incentives by financial firms an investor must know

In this year's economic survey, an entire chapter was devoted to the use of nudges to enhance the effectiveness of public policy. Whether you are aware of it or not, you, as investor and consumer, are being nudged in a variety of ways. Financial companies, the government, and retailers are constantly nudging to elicit the desired buying or investment behaviour from you. While many of these nudges are positive, some can also be negative. You need to be discerning enough to be able to protect your best interest.

What is nudging? Behavioural economics has shown humans often do not make the most rational and optimal choices due to factors like greed, fear and laziness. The way choices are designed and presented can have immense influence on how people make choices. This insight can, and is, used to “nudge” behaviour in the desired direction. Most people, for instance, are prone to inertia. By setting something up as the default option, the influencer can get the majority of people to go for it.

Mutual funds: Many investors begin investing in mutual funds, but do not enhance their investments in tandem with the increase in their earnings. Fund houses, therefore, now offer step-up (or top-up) SIPs. Here, the amount of SIP gets enhanced by a certain percentage, at regular intervals, say, annually. Left to themselves, people may not undertake the task of increasing their SIPs.

Many fund houses have tried to make it easier for investors to transfer the money lying idle in their savings account into a liquid account, where it can earn a higher rate of return. Aditya Birla Sun Life Mutual Fund, for instance, offers an Active Account App. After downloading the app, you need to complete a few formalities to create your account. Thereafter, with a single swipe, you can transfer money from your savings account to the fund house’s liquid fund. With another swipe, you can get it back.

   

Investors often find it difficult to make the asset allocation decision, that is, how much to invest in equities and in debt. One category that handles this responsibility on behalf of the investor well is that of balanced advantage fund. “As equity valuation goes up, equity exposure is reduced and debt exposure is increased, and vice versa. As a result, even if the equity market turns volatile, the impact on investments gets reduced owing to the cushioning provided by debt,” says S. Naren, executive director and chief investment officer, ICICI Prudential Asset Management Company.

Banks: Many banks now offer a sweep accounts. Here, a fixed amount, say Rs 25,000, remains in the savings account. Any amount above it gets swept out into a fixed deposit account. “By automating the process of moving money from a lower-yielding instrument to a higher-yielding one, customers can earn better returns,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisor.

Insurance companies: As a person moves through various life stages, his need for insurance cover changes. A young person’s responsibilities increase after he gets married, and again after a child is born. Insurance companies nowadays offer their customers the option to automatically increase the sum insured of their term plan at after landmark events in their lives. Since they do not have to apply afresh, or undergo medical tests, this is a convenient method for increasing term cover. The cost of this product may be higher than if you were to buy a separate term plan, but the effort required would also be greater in the latter process.

Tax benefits: Tax benefits offered by the government are the among the biggest nudges that influence financial behaviour. Witness the rush to invest in Section 80C instruments towards the end of a financial year.

In the recent Budget, the government offered investors the incentive to invest in central public sector enterprises (CPSE) ETFs, by giving them the same tax benefits as equity linked savings schemes.

To popularise National Pension System (NPS), the government has been steadily enhancing the benefits offered on it. “Earlier, the government had given an additional tax benefit of Rs 50,000 under Section 80CCD 1B. In this year’s Budget, it enhanced the portion of the final corpus exempted from tax from 40 per cent to 60 per cent,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor. In case of central government employees, it allowed employer contribution to rise from 10 per cent to 14 per cent, and also gave tax benefit to tier II account of NPS.

The life cycle funds in NPS also act as a nudge. Most retail investors in NPS find it difficult to decide how much to invest in equities, corporate and government bonds, and alternative assets. For many, changing the asset allocation with increasing age is equally daunting. By automatically reducing equity allocation as a person reaches closer to retirement, they make the investor's task much easier.

This year's budget also had an additional tax benefit of Rs 1.5 lakh for affordable housing. "It is likely to act as a nudge for first-time investors who were fence-sitters, especially since the benefit has been offered for a limited period,” says Raghaw.

Nudges in retail environment: The methods employed in the retail space to get you to buy more are so subliminal that most consumers are not even aware of being nudged.   

Have you noticed that in a mall, the perfume shops are usually on the ground floor? “When you come in from the sunlight, your eyes take time to adjust. The sensory perception that works well at that point is smell,” says Anil Pillai, a behavioural and cognitive professional, of Terragni Consulting. Both smell and lighting are employed to elevate the shopper’s mood and get her to shop more. 

Smells like those of baking bread and frying popcorn are known to whet the appetite for more purchases. Shelf layout is another influencer. “Products that retailers want to move faster are placed at the eye level,” says Harish Bijoor, brand expert and founder, Consults Inc. Similarly, products that remind you of one another are kept in adjacent aisles.

But be on guard against negative nudges

• Constant offers of loans and their easy availability can lead to over-leveraging
• Do not let the ratio of EMI to take-home salary cross 50 per cent
• Avoid the risk of over-leveraging by deciding not to take loans for consumption, only to create an appreciating asset like a house
• Hard-selling of traditional life insurance products, which offer low returns, using emotional nudges, can affect your financial health
• To avoid falling prey to retailers’ nudges, leave plastic money at home and carry only a fixed amount of cash to the mall