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.


SohamRoy said...

Actually we have been brought up like that. Hearing stories with happy ending, movies with no storyline/sense, but ending ecstatically! Maybe we are banking too much on Murphy's Law.
A few chai and a little gossip with any insurance agent will catapult him into safely getting his commission out of you, I have seen my parents doing this.
As we can see now, understanding the human psyche, bias is the new weapon of Mass destruction used by analysts in the name of Behavioral Finance. Though any substantive results or proof has been deduced out of Behavioral Finance, but after 2008 this is the New In Thing.

Arati said...

Hi Dinesh,

I was in the audience when you presented your session on Personal Finance at the Cisco Connected Women Leadership Forum event. My friends and I not only found your session humorous but really drove home the point.

Your session got me thinking about my investments and how I had perceived it so far. The one that struck me was about insurance. I have four insurance producs - money back policy, pension plan, ULIP (Birla's platinum plus), and term plan.

The reason I went with the moneyback policy from Birla in early 2000 was because I was impressed by the fact that the premium amount was invested in mutual fund/stock. Being a first-of-its-kind (as I thought then), I went it for it and so did many of my close friends. Thankfully, my pension plan is pegged at 10k, which I took to benefit from section 80D (not sure if got it right) because it was over and above the 1lakh we were required to save for tax. The platinum plus plan sounded good and my hubby and I fell for it. The only saving grace acc to me was we pay only for the 3 years. And the term plan I bought to cover my home loan risk (25lakh cover).

Based on your comment and also having read it and heard of it from many sources, I do beleive our mortality rate is higher than our forefathers. So I was planning to go for another term plan of say 50 to 75 lakh considering the inflation and standard of living (you had said we would need a minimum of 5 cr by the time we retire to live a decently comfortable life). The cover is for the next 30 years when I would surely have retired. So can you please advise me if I should go in for it?


Dinesh Gopalan said...

The term plan will yield the 50 or 75 lakh only in case of death, else you get nothing. In case of insurance, you have to assess how much you need based on loss of income if the person dies, whether the surviving spouse is working (in which case the dependence is less), etc. In case your savings are already high enough don't take an insurance cover. In case you think you will reach a "comfortable" net worth by another 15 years, then take term insurance for only 15 years. Remember that insurance is a cost and taken only for the specific purpose of covering loss of income due to death. Never regret any insurance that you do not take - the premium thus saved can be invested by you. The problem is that nowadays,since the insurance companies make good money on their products, they tend to push their products a lot - the whole thing, according to me, is a bit overhyped.

Arati said...


Thanks for your valuable advice and for all these useful posts. I'll keep coming back! :)

Anonymous said...

The only certain thing in life is death. But we are taught to ignore death and even more about talking of death! Fear of death is more dangerous than death itself. But a pious soul is ready to receive the death of the mortal body at anytime the call comes. thinking of death or its arrival need not restrict our outlook to life; it should rather spur us into more action and result oriented efforts....Keshava Murthy