If I were to ask you to add 17 five times, you would swiftly do the calculations in your head and give me the answer “85”.
It is easy to add or multiply smaller numbers.
17+17 = 34 + 17 =51 + 17 =68 + 17 =85
However, if I were to ask you to, “What is 17 raised to the power 5?”, would you be able to answer this question without a calculator or at least pen or paper?
As a kid, I memorised 17 squared is 289 and that’s it.
Beyond it, I can’t do the calculations in my head.
17^5 = 17 X 17 X 17 X 17 x 17 = 1,319,857
Most of us are not capable of doing these complex calculations in our head.
Therefore, most of us will go by what the presenter says. Not many will open calculators and spend some time verifying/cross-checking the calculation.
By the way, 17^5 is 1,419,857 (and not 1,319,857).
Now, this is a problem
If you are not willing to spend time about what is being said, many salespersons will have a field day at your expense.
In most walks of life, we try to ensure that we get the value for the price we pay. While purchasing garments, we check the quality of cloth. If we are unsure about the price, we check the price at multiple shops to ensure that we are not being overcharged.
However, many of us don’t do such diligence when it comes to purchasing a financial product.
Most times, the problem is either the lack of mathematical skills or limitation of our brains. I will discount the inability to comprehend pros and cons of a product for now.
Let’s consider an example
You pay me X amount per year for 10 years and I will pay you 1.5X every year for 10 years from the 11th year.
Will you sign up for this product?
If you ignore the time value of money, it looks like a good deal. You pay Rs 1 lac per year and get Rs 1.5 lacs per year. You will perhaps sign up.
However, if I were to tell you that the rate of return on this product is 4.14% p.a., you will say NO right away. After all, you can get this level of returns even if you keep your money in a savings bank account.
Clearly, if I were a salesperson, I will stay away from any discussion about the returns. And, if you don’t realize what you are getting into, you will perhaps never take the discussion in that direction.
You need to ask the right questions. You need to understand the numbers. You may not be able to do all these calculations in your head. However, if you have the time and patience to go back and revisit the numbers (in excel), you can avoid being a victim of mis-selling. You can also seek help from a friend or an advisor.
Examples: Where our maths skills can let us down
In another post (Corporate Fixed Deposits: Do not fall for misleading interest rates), I discussed how companies were deliberately trying to mislead investors and pass off reasonable returns as very high returns.
In both the examples, most of us wouldn’t care to look beyond the cosmetics and accept the advertised numbers or sales pitch at face value.
In a few cases, our inability to understand a product structure can let us down. It is not difficult to understand that returns in a ULIP or a traditional life insurance plan will go down with your age (at the time of entry). No salesperson will ever talk about this. They won’t mind selling it to an 80-year old, for whom such a product is doomed from the beginning.
You have got to appreciate this on your own.
No one ever talks about why the same amount of life cover costs more in a ULIP than in a term life insurance plan. Insurance companies rip you off by way of mortality charges in ULIPs.
ULIP fund returns can be misleading for these returns are before charges.
Recently, a pension plan from a prominent insurance company was in news. The plan claimed to provide 12.5% p.a. guaranteed income for life.
There has to be a caveat.
And the caveat is: You pay lump sum of X. After 10 years, you will get annual income of Rs .125X per annum for life. The key is “After 10 years”.
Now, if you were to invest Rs X at 6% (post-tax) for 10 years, you would have Rs 1.79X with you.
.125X on a corpus of Rs 1.79X is only 6.97% p.a. Far cry from 12.5% p.a. that would be shown during sales pitches. By the way, this is when I assume the annuity is with the return of purchase price (Rs 1.79X).
I don’t want to comment on a specific insurance company or a product. The intent is to demonstrate that you can’t take presentations or sales pitches at face value. You need to dig deeper.
As I always say, when it comes to assessing financial products, Excel (spreadsheet) is your friend. If you can’t do this yourself, find a friend who considers Excel his friend.
Stay away from rhetoric.
Don’t let the numbers fool you.