The leader of the Sahara Group, Subrata Roy, passed away only a few days ago at the age of 75. The Sahara India financial scandal, a dark chapter in which the party disregarded legal requirements and issued financial instruments, has marred Roy’s legacy, especially for investors from the lowest economic strata who often had no knowledge of the products, resulting in serious consequences.
According to an S&P investigation, the issue of mis-selling has deep roots in a nation where more than 70% of the population struggles with financial education. Numerous instances exist where investors were misled into making decisions that were not in their best interests due to false, deceptive, or incomplete information about financial products.
While pyramid/Ponzi schemes are well-known for deceiving investors, mis-selling has taken other forms, including unit-linked insurance plans (ULIPs) being presented as mutual funds and the sale of additional Tier 1 (AT1) bonds to conservative investors without disclosing all of the risks. Additionally, misrepresenting payouts has been used to sell mutual fund dividend plans, creating exaggerated earnings expectations for unsuspecting investors.
The issue persists despite efforts by officials and financial organizations to protect investors by enforcing rules and regulations to prevent and penalize mis-selling techniques. In light of this, here are five crucial tactics you can use to protect yourself from falling prey to financial mismanagement.
1. Beware Of High-Pressure Selling Techniques
High-pressure sales tactics use aggressive and manipulative methods to convince unsuspecting individuals to make hasty decisions without fully understanding the risks or relevance of a financial investment. These tactics compel people to buy products that may not be suitable for them.
Mis-sellers create a sense of urgency by claiming that the investment opportunity is limited and might not be available if the person doesn’t act immediately. People may make impulsive decisions due to this perceived urgency.
Sellers/agents may declare that a specific discount or prize is only available for the next 24 hours if you invest “NOW,” taking inspiration from consumer goods marketing tactics. Mis-sellers have sometimes asserted that the investment opportunity would soon be closed for certain uncontrollable banking products. Additionally, the use of countdown timers in advertisements or on websites can create a false sense of urgency.
Mental Manipulation: Most of the mis-selling involves psychological manipulation. The use of psychological tactics is crucial in high-pressure sales. These tactics often involve exploiting emotions, such as the fear of missing out (FOMO) on potential profits. Sellers aim to override rational decision-making and compel people to act immediately by evoking strong emotions.
They may remind you of the dreams you’ve always had, such as luxurious vacations, a beautiful home, and financial independence, implying that this purchase is the key to realizing your dreams. If the so-called advisor is familiar with you, they might seal the deal by citing personal anecdotes and recommending acquaintances. For instance, many senior citizens were sold bonds by relationship professionals at YES Bank AT-1 bonds as a “high-yield but super-safe product aligned with Configuration.”
Constant Follow-Up and Persistence: Mis-sellers continually pressure the customer to make a decision through persistent follow-ups. This persistence often serves as a motivator.
For example, thanks to ubiquitous mobile phones, anyone can be reached at any time. You might pick up the phone once or twice or even say “not interested,” but telemarketers continue to follow up, making customers feel obligated to do the same. Steady follow-up also fosters a sense of urgency.
Overestimating Potential Profits: Mis-sellers downplay associated risks while exaggerating the potential returns of an investment. By highlighting the positives, they create the illusion of a “low-risk, high-reward opportunity.”
For instance, they often display the highest returns for these products as if they were standard investment returns. To achieve this, they may use website links, newspaper articles, or magazine pieces. Small-cap fund mis-sellers frequently emphasize gains in specific calendar years (e.g., 2009, 2014, and 2021) before extrapolating the same over 10 to 20-year intervals!
Building swift trust or rapport with the person is one of the high-pressure tactics used to increase their receptivity to the sales pitch.
For example, some con artists are known to provide unusually high levels of personalized attention to foster a sense of closeness and trustworthiness. As a result, individuals may find it more challenging to question the legitimacy of the offer or fully comprehend the hidden agenda. When given significant personalized attention, clients have in some cases withdrawn long-term investments to invest in short-term schemes.
Pseudo-financial planning games are also effective. Some agents have taken advantage of their relationships with senior citizens by selling them market-linked debentures (MLDs) on unfavorable terms. Mis-sellers have found success by offering a cursory financial plan for “uncle/aunty,” as seniors may live alone and seek attention from younger individuals. Playing on established stereotypes, such as a pleasant demeanor, an authoritative tone, or dressing professionally, can be very effective in impressing gullible investors.
Use of Complex Jargon: People may be more likely to give in to pressure out of fear of appearing ignorant when they don’t fully understand the technical language being used. When complex jargon is combined with time pressure, individuals may feel they don’t have enough time to fully grasp the complexities of the investment, leading them to rely more on the seller’s advice—precisely what the mis-sellers want!
Complex language can make investments appear more unique and superior, pressuring individuals into making decisions without fully understanding the complexities involved. Cryptocurrency investments, for example, often use decentralized blockchain technologies, negative consensus algorithms, and other jargon to attract buyers. This has a greater impact than simply advising people to invest in this new digital currency system, which uses cutting-edge technology to ensure security and reliability.
2. Never Disregard Costs and Charges
The clarity and disclosure of fees, charges, and claims associated with a product are crucial factors that should never be ignored when considering financial investments. A lack of transparency in this area can reveal potential issues with the purchase and raise red flags.
Investors should be cautious if there is no information at all about the costs, fees, or charges associated with the investment. In such cases, a lack of transparency can lead to unpleasant surprises and make it difficult to make informed decisions.
For example, in the past (before 2010), there were numerous instances where ULIPs were sold without mentioning high premium allocation charges (PAC) ranging from 10% to 20%. Many ULIP investors only realized how much these hefty PACs were eating into their investments after a few years. Naturally, regulatory authorities introduced rules to prohibit ULIPs from charging exorbitant PACs.
Another red flag is agencies and advisors who fail to disclose the commissions they will receive for promoting specific financial products. Honest and transparent professionals should openly discuss the compensation they receive to ensure investors are fully aware of any potential conflicts of interest.
If officials or advisors dodge or divert questions about fees, costs, or charges, it may indicate an attempt to keep investors in the dark. Investors should be cautious of those who appear reluctant or unwilling to provide such information and should demand clear, straightforward answers. For example, while mutual fund broker commissions typically range from 0.50% to 1.00% of the Assets Under Management (AUM), investment plans and money-back insurance policies offer much higher commission rates, which is why agents promote these plans more than pure-term policies. Renewal policies pay higher commissions compared to single-premium policies, which also raises questions (in terms of percentage).
3. Watch Out For Regulatory Compliance
Another red flag is a lack of information about regulatory oversight. To verify the legitimacy of a financial product, investors should inquire about the regulatory body responsible for it. Do not rely solely on official-looking documents or logos; independently verify them. Credible investments are typically regulated by reputable government authorities, and information about this oversight should be readily available.
Recently, some financial schemes have been promoting investments in agriculture and farming by pooling funds from numerous investors with guaranteed returns of 10% to 15%. Such collective investment schemes, which should typically require approval from the Securities and Exchange Board of India (SEBI), have not followed these regulations. In the past, many relationship aggregator platforms sold various bonds, including unregistered ones, without proper regulation. SEBI had to intervene and introduce standards for online bond platform providers to regulate this market.
A strong financial product may have a clear redressal or grievance resolution system in place. If there is uncertainty or a lack of information about how complaints or issues will be addressed, buyers should exercise caution. A well-defined procedure for resolving complaints is a sign of an honest investment.
4. Ask Pointed Questions
Investors entering the world of financial investments can ask specific questions to ensure a comprehensive understanding of the product and mitigate potential risks.
Understanding Risks: Buyers should research the potential risks associated with the investment. What are the potential downsides to the investment’s performance? Investors can make informed decisions by seeking a thorough understanding of the risks involved. For instance, when some investors eagerly purchased high-yield credit/debt mutual funds from Franklin Templeton MF before the COVID-19 pandemic, they were unaware of the true significance of illiquidity, high-offer funds, and other factors. It was only during a market dislocation caused by the onset of the pandemic that they realized the risks, as liquidity was drained from the fund’s underlying holdings.
Investors should seek clarity on all terms and conditions, including those presented in fine print. By asking specific questions about legal responsibilities, penalties, and any hidden clauses, buyers can ensure they fully understand the terms governing their investment.
Other documents are often overlooked due to small font size. However, as the saying goes, the devil is in the details. Official documents contain critical information, that is frequently missed, whether it’s a bank product, mutual fund offering, or insurance policy.
By being aware of the circumstances under which an investment can be exited and the associated costs, investors can plan their financial strategies effectively.
Assess Investment Performance History: Instead of relying on short-term or selectively chosen data, investors can request the fund’s performance history over a significant period of time. Requesting performance information beyond a single season provides a more accurate picture of how the investment has performed under various market conditions.
For instance, many investment opportunities today include “presentations” that display back-tested data for selected strategies to demonstrate how profitable these options would have been if people had invested in them 15 to 20 years ago. Back-tested data doesn’t use real data and often involves adjusting the method, known as curve fitting or overfitting, to fit historical data properly. This can result in a strategy that, while effective in the past, is ineffective in current or future market conditions. It’s a significant red flag when someone emphasizes such data to persuade you to invest.
Verbal assurances may not provide a solid enough foundation for comprehending the complexities of an investment compared to written information. Investors should request prospectuses, offer documents, and any relevant literature along with written information. Written documentation reduces the likelihood of misunderstandings by providing a specific point of reference.
For instance, some investors were mis-sold payout plans of hybrid funds a few years ago. These plans promised continuous generation of consistent dividend income and capital appreciation from the initial investment. However, when markets fell, it was impossible to maintain consistent earnings. Additionally, changes in dividend taxation regulations made this route less appealing (dividends from equity-oriented funds were tax-free until March 31, 2018).
5. Verify The Credentials Of Advisors
Verifying the credentials of advisors is an important first step in safeguarding your assets when seeking financial guidance.
Avoid Bank Relationship Managers: While banks offer a range of financial services, relationship managers (RMs) may have sales targets that influence their recommendations. In general, it’s best to exercise caution and consult with independent experts rather than those associated with specific financial institutions.
Use SEBI Registered Investment Advisors: When seeking investment advice, prioritize consulting with the Securities and Exchange Board of India (SEBI)-registered advisors. Investment advisors registered with SEBI (see the list here: SEBI Registered Investment Advisors) adhere to regulatory standards and provide a level of assurance regarding their qualifications and ethical conduct. Fee-only advisors are compensated solely by their clients, reducing potential conflicts of interest and aligning their interests with yours.
Prudence in Insurance Advisory: The world of insurance can be complex. Beware of persuasive agents and prioritize consulting professionals known for providing accurate guidance. Additionally, consider speaking directly with clients of these advisors to learn more about their actual experiences.
Instead of seeking feedback on products from vendors or providers, approach registered advisors. To gain an objective understanding of the experiences of those who have sought the advisor’s guidance, reach out to them directly. Tools like portfolio software can be valuable for obtaining honest recommendations.
Conclusion
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