Friday, February 4, 2011

Tricks of the mind

You will never hear an insurance salesman say "when you die…" or even "if you die…". It is always "if something unfortunate happens…". We don't want to hear bad news, not even contemplate about possible bad events in the future. Most of us tend to put off buying insurance or writing wills for this reason; we do not want to contemplate our own deaths. A lot of things in life can be attributed to running away from the fear of the inevitable; some things in financial planning included.  There is also a cultural bias here. In most cultures it is considered inauspicious to talk about bad things. And death, everyone agrees, is a bad thing.


In the middle of our straitened, stressful circumstances, we all dream that one day the clouds will open, and a huge light full of blessings will descend on us from heaven. There are enough instances in mythology of heroes being showered with flowers by the Gods – the fact that they did something extremely heroic to deserve it is often forgotten.  Every alternate fairy tale is about the poor Cinderella meeting her Prince; only the settings differ. All religions promise deliverance in the hereafter. Religions also impose stiff conditions to the deliverance, but we do not want to think of those difficulties all the time. We always want to believe in the ultimate deliverance; life will somehow ensure that we reach there.


Financial products exploit this to the hilt. The Pension Plan has a promise attached to it that in your retired life, you will keep getting a monthly income; the Child Plan advertisements show some children playing on the beach, and your child playing with a stethoscope around her neck, playing on our sentiments, and somehow managing to convey that investing in that plan will ensure that your child will become a doctor. Never mind that the child may have other ideas; or that the amount you get will depend on the amount you put in. More important, never mind how and where the investments are made, what are the charges, commissions, and leakages; and is that the best use of your money? We will subscribe to the plan, contribute a few thousand rupees a year, and happily live in the illusion that we have taken care of our child's future. Ditto for daughter's marriage. Marriage plans are very popular too.


The Child Plan, Marriage Plan, or any such "life goal" plan from any insurance company invests in some equity and some debt through a mutual fund inbuilt into it. After deducting a lot of commissions. Why can't we save on the commissions and invest directly in equity or debt ourselves through mutual funds? It has the same effect, while saving a huge lot on commissions. We perhaps do not want to do that since the end use is not labeled – how are we sure that we are taking care of our daughter's marriage, or child's education, unless someone labeled it as such? Also, we do not want too much transparency – the opaque structure of these products suits us since we want to live in the assurance, never mind its full or complete validity, that we are doing our duty – please let me not know how I am doing every once in a while. Why swallow the bitter pill of reality every time – the comforting opiate of faith and hope is no doubt better?


We repeat our puja every day, and go to the temple every Tuesday. That gives us a lot of comfort since we are taking care of our after-life through some rituals which promise deliverance. Religions have rituals which hold the promise of unleashing great potent forces; so does financial planning!


When you ask share traders about their trades, you will always hear success stories more than stories of losses made. Partly it is deliberate, the desire to impress others through stories of success. Partly it is due to the fact that the mind tends to forget the bad experiences over time, or discounts their importance, and builds up the good ones. In terms of evolution this may be a desirable thing since optimistic and positive minds tend to live longer and happier, but in terms of decision making such forgetfulness may not be the ideal thing. This may induce us to get into risky trades without considering the downsides. Several times, when we are sold on some investment, we want to avoid going into the downsides; our mind rejects all the negatives and soaks in the positive news. Not a different state of mind from someone in love and possibly not married – the mind sees only positive things about the beloved. Marriages and staying together are known to shatter such illusions. But as in the case of investments, it may be too late – you have already bought into it.


There is the other extreme too, that is very common.  There are people, in fact many of them, who are so afraid of taking risks, that they will invest only in Fixed Deposits. With nationalized banks. "No shares for me, thank you, they are too risky". "Real estate? I have heard enough stories of people losing their land to encroachment". They are very happy to earn 7% pre-tax on their FD's while inflation runs at 9.  But they sleep better.


Morals to these stories? When it comes to investments there are several morals you can pick. Whether you derive morals from them or not, it is good to be aware of these tendencies. One of the things a good investor needs to avoid is self delusion. And as seasoned investors will vouch, that is the most difficult thing to do.