Course Content
How does money work?
To start understanding money, we need to understand how money works. There are concepts like Pay Yourself First, Magic of Compounding, Time Value of Money and Cost Averaging that would help you understand money.
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Recommended Reading
List of blogs and books for reading
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The Cost of Free Advice
Case studieson the cost of advice.
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The Psychology of Money
Read how your mind works when it comes to matters about money
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Financial Literacy for School Students
About Lesson

Even though we pay for advice from a Chartered Accountant, Advocate or a Doctor, we are also used to “free” advice when it comes to buying a financial product.

Probably the reason we pay the professionals like Doctors, CAs and Advocates is because they have spent years in learning and refining their professional expertise. They provide answers, solve your problems and you benefit from consulting with them.

Advice is free; the right answer will cost plenty – Mary Worley Montagu

But even though the financial advisors can or should add a lot of value to your finances, paying your financial advisor has never occurred to you.

This is probably because a majority of them do not really merit a fee. Anyone can become an insurance agent or a mutual fund advisor or a stock advisor. Most of them seem to be saying:

Take my advice; I don’t use it anyway –Author untraceable

A Doctor spends atleast 8-10 years studying and getting a degree and license to practice. A financial advisor does not need even 8-10 days.

Let us take a look at what is happening in the Insurance industry in India. The key strategy of insurance companies for increasing their business is to recruit more and more agents. But while there are additions in the agency workforce, due to lack of professional standards, huge numbers fall off the system too.

In the two financial years (2009-10 & 2010-11), the number of agents terminated were 19.38 lakh. 16.39 new agents were recruited in the same period of two years. The life insurance industry has 26.39 lakh agents on roll as on 31.3.2011.

The two years have been bad for insurance companies when it comes to recruitment of agents as the terminations have outnumbered additions. This is reflecting in the growth of business.

But generally the recruitment of new agents is more than the terminations. So, 10 years ago, there were around 15 lakh agents and it has grown to 26 lakh today. In the process of recruiting new agents, a guess estimate of the number of agents terminated in the last 10 years would be more than 60 lakh! The business done by these 60 lakh agents would be of their near and dear ones who took policies out of friendship or relationship.

Today the policies done by these 60+ lakh agents would be orphan apart from not being need-based.

IRDA report 2009-10: Such high turnover in the agency force is a matter of concern, as it could have negative consequences for the life insurance industry as a whole. The policies procured by these agents are rendered “orphan” upon termination of the respective agent, and thereafter often result in lapsation due to absence of servicing support. The image of the profession of agents too suffers a setback since the public in general, and prospective agents in particular, perceive it as lacking in stability, thus making it more difficult for insurers to enroll committed agents.

 

There’s one more reason why there’s lack of professionalism in the financial services industry. It’s because of the customers of financial services. Yes, that’s you and me!

Most people are too busy with other things when it comes to taking decisions on money, even though it’s one of the important aspects of their lives. They will spend endless hours debating the political issues, watching TV, in social gatherings and / or researching the cool gadgets they want to buy.

And when it comes to money, a lot of people appear to have a brain freeze. It’s not my cup of tea, they whine. They don’t take the trouble of researching the right advisor and analyzing financial products. Even when we know that money is important!

So there are two major reasons that explain the present quality of financial advice. One, becoming an advisor is easy and profitable. Anyone with an eye on commissions can become an advisor and make money. Two, there are a lot of busy, unsuspecting clients available for the new and hungry advisors! These unsuspecting clients don’t bother about making informed financial decisions and become easy preys to the advisors.

Commonly available advice: Good or Bad or shades of grey?

Mr. Deepak Kumar is a software engineer and is a very busy person. He is a methodical person and is very careful with his finances. He is being regularly approached by insurance agents and he takes time out of his busy schedule to compare all the product recommendations before settling for a policy.

The policy that he buys combines risk coverage, maturity benefits and also additional benefit to the family when he will pass away.

Mr. Kumar selects the company which is the most trusted brand instead of paying lesser premium from lesser brands.

The yearly premium for the 25 lakh coverage amounted to Rs. 1.80 lakh and he could easily afford Rs 15000 every month. The maturity amount and the death benefit illustrations shown by the agents also looked attractive.

The agent suggested that he open an account where he transfers Rs 15000/- every month and pays the premium annually. This arrangement would entail discounts from the Insurance Company and also get him some interest from the Bank.

Mr. Kumar agreed and was quite happy with the advice of the agent. He was happier when the agent offered to pay one month’s premium on his behalf.

The agent had an office and was providing professional services. The agent promised that he will collect the renewal premium cheques on time and will provide all service for the policy.

So Mr. Kumar puts Rs 15000 every month in an account and pays an annual premium of around Rs 1.80 lakh in a policy that will ensure insurance protection for his family, give him decent returns when he retires and also ensures that the family gets good money when he finally passes away.

Mr. Kumar is happy. He got great advice and that too free. The fact is, he got paid a bribe for taking the policy. The agent is happy and the Insurance Company is happy too. A win-win-win situation, one should say.

But let’s dig a bit deeper.

  • The insurance coverage of Rs 25 lakh is not really adequate for Mr. Kumar. Mr. Kumar earns around Rs 10 lakh per annum and the insurance coverage will not be enough to manage expenses beyond three – four years. Moreover, his responsibilities towards his children’s education & wedding would not be taken care of by the insurance coverage. Plus, his home loans would also not been taken care of by the insurance protection.
  • The agent is happy because he got around 25% commissions for the first year. That amounts to Rs 45000/- So even after paying Rs 15000/- to Mr. Kumar (as rebate aka bribe aka illegal) for taking the policy, he makes a cool Rs 30K for the free advice. The agent will continue to earn commissions till the premiums are paid, i.e. for another 20 years.
  • The returns of the Insurance Company are based out of their own investment yields and by and large Insurance Companies invest in safe Government securities and bonds. After deducting the Companies management and administrative expenses, the returns to the policyholders generally will hover around the returns generated by bonds, i.e., not more than 8% in the current scenario.
  • In any case, the returns offered by Insurance companies do not beat inflation.
  • Now there are financial products available that beat inflation handsomely. Over a period of 20 years, the index has given a return of more than 15%. There are Mutual Fund schemes that have over – performed the index. But they need to be researched and found out of 1000s of Mutual Fund schemes available in the market.

What’s the cost of having free lunch parties or free beer?  Nothing, but a pot belly!!

Did Mr. Kumar get the right advice? Was the advice that Mr. Kumar got really free? What was the cost of the free advice? Let’s find out!

See Deven Shah’s (Founder, Wikipaisa ) video on Free or Fee Advice at http://wikipaisa.com/right-to-credible-financial-advice/your-vote-counts/

Camera!: Cost of Free Advice is more than One Crore!

Why pay for financial advice when you can get it for free? You get it free from friends, colleagues, relatives, bank executives and insurance agents, right?

But have you ever wondered that the free advice might cost you a lot of money? For example, if you buy costly insurance plan that you don’t need or a mutual fund that does not suit your investment profile, you will lose money that you could have got from more useful investments.

You lose much more than the annual fee of a financial planner. True Financial Planners are not Advisors or Product Sellers and they prepare a Financial Plan that is based on your need, your situation, your goals and your risk appetite.

Let’s take a hypothetical example to find out the cost of free advice. Let us assume that a paid financial plan where the recommendations are not based on commission considerations will fetch you a better return. Ofcourse it is a hypothetical example but bear me with an open mind.

 Here are the assumptions. Imagine you invest Rs 15000 every month and that adds up to Rs 1,80,000/-. We have assumed the returns for 8% and 10%. Though the commission from insurance products are higher, generally the commissions work out to just 2% of your investments and the difference between the returns @ 8% and 10% would be the cost of free financial advice.

Initially the difference looks too small. It is only Rs 3600 in the first year and approximately Rs 68000/- for an investment of Rs 9 lakhs after 5 years. But the difference continues to compound and the difference of Rs 1,05,47,560 happens at the end of 30 years!

Here’s the table that calculates the cost as Rs 1 crore, 5 lakhs, 47 thousand and more!(Rs 1,05,47,560/-)

Ye ar

Invest ment

Growth @8%

Invest     ment

Growth @10%

Differ ence

All figures in lakhs

1

1.80

1.94

1.80

1.98

0.04

2

3.74

4.04

3.78

4.16

0.12

3

5.84

6.31

5.96

6.55

0.24

4

8.11

8.76

8.35

9.19

0.43

5

10.56

11.40

10.99

12.09

0.69

6

13.20

14.26

13.89

15.28

1.02

7

16.06

17.35

17.08

18.78

1.43

8

19.15

20.68

20.58

22.64

1.96

9

22.48

24.28

24.44

26.89

2.61

10

26.08

28.16

28.69

31.56

3.40

11

29.96

32.36

33.36

36.69

4.33

12

34.16

36.89

38.49

42.34

5.45

13

38.69

41.79

44.14

48.55

6.76

14

43.59

47.07

50.35

55.39

8.32

15

48.87

52.78

57.19

62.91

10.13

16

54.58

58.95

64.71

71.18

12.23

17

60.75

65.61

72.98

80.28

14.67

18

67.41

72.80

82.08

90.29

17.49

19

74.60

80.57

92.09

101.29

20.72

20

82.37

88.96

103.09

113.40

24.44

21

90.76

98.02

115.20

126.72

28.70

22

99.82

107.81

128.52

141.38

33.57

23

109.61

118.38

143.18

157.50

39.12

24

120.18

129.79

159.30

175.22

45.43

25

131.59

142.12

177.02

194.73

52.61

26

143.92

155.43

196.53

216.18

60.75

27

157.23

169.81

217.98

239.78

69.97

28

171.61

185.34

241.58

265.74

80.40

29

187.14

202.11

267.54

294.29

92.18

30

203.91

220.22

296.09

325.70

105.48

 

Now, there would be some limitations of this calculation by way of the assumptions we have made. But that’s not the point. The bigger point is that there is a huge cost of free advice that we don’t see but piles up big time over a period of years.

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