Risk and complexity in investments: What's in it for the seller?
In part 4 of this series, we look at keeping a healthy scepticism
This is the final article in a four-part series about questions to ask yourself before taking an investment decision.
Shocking as it may seem, a financial advisor/institution selling an investment product may not have the client’s best interests at heart but rather their own (written with a hint of irony). The easier accusation would be that they offer to sell you the product on which they earn most commission, although this is almost too easy.
Check the product charges, check the predictions, check what happens to both upside and downside risk. While downside risk relates to losses, upside risk relates to gains.
A local financial institution, for example, had offered to purchase bonds for their clients that paid above six per cent* but they promised six per cent to their clients. That means that if the bonds paid more, the financial institution was taking advantage of upside risk by retaining any income above the six per cent. That would have been reasonable if the financial institution was also taking downside risk, as most insurers which offer life investment products do. Instead when one of the bonds failed, the financial institution just advised investors that they lost part of their investment.
Hence this financial institution was making profit from the excess of interest paid above the 6 per cent, charging tariffs, taking upside risk of any currency fluctuations but no downside risk. This financial institution abused the financial illiteracy of its clients to its advantage. Immoral? Yes by any margin. Legal? Apparently so.
The clients would have still taken the plunge in these investments after asking the three questions each of this series’ previous articles asked: the investment had virtual spread of risk, was relatively safe and was not that complex. But clients failed to ask the fourth question. Don’t make the same mistake.
These questions are intended to provoke discussion and are not an exhaustive list. Do you have an investment decision-related issue you think Dominic should consider? Contact him on Twitter @domcortis or on LinkedIn
*The figures used are fictional. The case sadly is not.