If you were to convey to a new investor that mutual fund investments are risky and you can lose your capital if you invest in equity mutual funds, which disclaimer will be better?
- Don’t come crying to us if we lose all your money
- Mutual Fund investments are subject to market risk. Please read the scheme information and other related documents carefully before investing.
Clearly, the first one. Why? Because it is easy to understand.
What about the second one?
Well, how many new investors understand what “Market risk” means?
According to Investopedia,
Market risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets in which he is involved. Market risk, also called “systematic risk,” cannot be eliminated through diversification, though it can be hedged against. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks.
Who will understand this?
Many retail investors come to markets when the markets have already run up significantly and lose money because they do not understand market risk. And it does not end at that. There is tonnes of verbiage in the scheme information document. It is imprudent to expect a new investor to go through all the pain to invest in mutual funds.
Yes, I do understand such disclaimer goes to the other extreme and might give the impression the fund managers are not serious about your money. Such disclaimers may even turn away customers. This is not clearly desirable when you want MF industry to grow.
And I am not saying that MF industry should use such disclaimers. I am also not saying that investors should not do research before investing in funds. All I am saying is that the risks of any investment (and not just mutual funds) should be explained in lay terms.
Disclaimers should be such that it allows investors to easily understand the risk involved in such investments and assist their decision making. For instance, something like You can lose money if you invest in mutual funds is much easier to understand. This explains the risk of investing in equity funds in such simple language.
MF industry can argue insurance companies do not offer such disclaimers in their advertisements and such restrictions put MF industry at a disadvantage to insurance companies while competing for investor funds. That’s right.
IRDA, the insurance regulator, has much to do in this regard.
What if IRDA asks insurance companies to provide following disclaimer/disclosure for traditional plans in all advertisements?
“The returns from this plan will be in the range of 4-6% and such returns may not beat inflation. You will get better returns in PPF”
This kind of disclaimer can easily be given for non-participating traditional life insurance plans because the returns are known upfront.
Investors will also be able to understand what they are getting into and will likely get very low returns. If they still choose to purchase, it is their choice.
What do you think ?
Credit
Kuldeep, a friend and client, shared an article by Jason Zweig in Wall Street Journal where Jason wrote about risk disclosures in investment industry. Jason is a personal finance columnist with Wall Street Journal and has written/edited many books on investing. As mentioned in the article “Don’t come crying to us if we lose all your money” was part of Risk disclosure by IPS millennium fund in US.
