Last Updated on November 15, 2019 at 11:48 am
Dalal Street’s (slang for the financial services industry) primary focus is to transfer wealth from the client to Dalal Street. Dalal Street knows that clients will not hand over all their net worth at one go. So instead, Dalal Street uses a very effective technique called ‘salami-slicing’. In this context it means, Dalal Street fights a battle to get 1% of the client’s net worth each year. Avinash Luthria, SEBI Registered fee-only investment advisor explains five tactics used to achieve this and how you can protect yourself.
Avinash is Founder, Fee-Only Financial Planner & SEBI Registered Investment Adviser (RIA) at Fiduciaries. He was previously a Private Equity & Venture Capital investor for 12 years and has a flagship-course MBA in Finance from IIM Bangalore. His articles have appeared at Business Standard, Mint and The Ken. See: publications You can read his previous guest articles here:
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Dalal Street tries to extract 1% of the client’s net worth each year in various excess fees for managing the client’s money such as almost all insurance investment products, high-cost mutual funds (MF), high-cost Portfolio Management Services (PMS), distributor commissions for all these products and expensive investment advice. If Dalal Street can do this over 30 years, then Dalal Street will manage to transfer roughly 30% of the client’s net worth from the client to Dalal Street.
The battle for 1% p.a. will determine whether you will survive retirement
Since 1% seems to be a small amount in exchange for the hope of getting rich, clients don’t realize that there is such a battle going on. Clients do not even realize that they are overpaying by 1% each year. And clients definitely do not realize that the cumulative impact of these little drops of water is devastating — losing in the ballpark of 30% of their net worth. (Losing 1% or 0.01 of your net worth can be mathematically represented as 0.99 in year 1. 0.99 in year 1 multiplied by 0.99 in year 2 is equal to roughly 0.98 at the end of year 2. 0.98 means that you have lost 2% of your net worth in 2 years. And so on over a total of 30 years.) Let’s look at five tactics that Dalal Street uses to achieve this. This may help you identify such tactics and protect yourself against them.
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Using salesmen who are ignorant and hence can sell with a clean conscience
Dalal Street picks salesmen who don’t understand finance and it tries its best to keep them ignorant about finance. A salesman that does not understand that he is selling a deceptive product is more effective than a salesman who understands that he is selling deceptive products and hates his job. There are a few salesmen who knowingly sell deceptive products because it is the most effective way to provide for their own families. If we were in a similar situation, almost all of us would do the same.
A terrific story
The human mind is wired to love stories. So Dalal Street creates a terrific story and most clients will fall for it. Some of the best stories are — the story of the ‘free lunch’ e.g. “instead of term insurance where you will get no money back if you survive, pick an investment plus insurance product”. Or the story of ‘getting the upside with no downside’ e.g. Structured Products; “equity is safe in the long-term of 5-10 years. Or the story that ‘past returns prove that…’ e.g. “past returns prove that our fund manager is a genius”; “back-testing proves that this investment strategy generates very high returns”. Editors note: This is a relevant livemint article published by the author – Why it’s a myth to say that equity is safe in long term
The Ashwatthama trick
Dalal Street has an army of people to use statistics and math to deceive you without breaking the law. For example, Dalal Street will merge MF schemes that have poor performance into MF schemes that have good performance. Hence the MF schemes with poor performance will disappear from view and you will wrongly conclude that most active MFs beat the index. See: Active funds may not beat index as most don’t give remarkable returns
Or Dalal Street will show you a graph for a Structured Product and focus your attention on the normal range of outcomes and get you to ignore extreme outcomes. The graph will show that in almost all situations, the Structure Product performs better than the Nifty index. The name of the product, e.g. ‘Debt Structure’, will imply that it is a safe product. But Dalal Street did not explicitly say that the product is safe, so they did not break the law. It’s only after you invest and there is a major stock market crash or when you figure out how to calculate the outcome in extreme situations, will you notice the situations where the product is significantly worse than the Nifty. So much so that you might lose your entire investment in the product. See: How even DIY investors can benefit from a registered investment advisor!
Complexity, Opacity and Fine print
An example of complexity is the large number of fees in a ULIP. An example of opacity is that early-stage technology Venture Capital fund’s use a subjective and optimistic approach to value their portfolio of loss-making companies so that in the interim, they can raise their next fund. Editors note: This is a relevant livemint article published by the author – Why individual investors should avoid alternative investment funds
A great example of mind-numbing fine print is all health insurance policies and critical illness/disability insurance policies Editors note: This is a relevant livemint article published by the author. See the section on ‘Disability and critical illness risk: Three financial risks to plan for before retiring.
Dalal Street knows that if a client tries to dig through all this, then fatigue will set in and the client will probably give up and sign up. That is why Dalal Street employs another army of people to generate complexity, opacity and fine print.
Pointing to third parties who provide credibility but who are not aligned
PMS managers will show you that a Chartered Accountant (CA) has signed off on the excellent returns of say their ‘Midcap strategy’. If a particular CA asks about the large number of other strategies that performed poorly, then the PMS will just pick another CA who is willing to ignore this. The PMS then focuses their sales effort on the one strategy that, due to randomness, had high ‘returns since inception’. And the PMS avoids mentioning that most of the other strategies performed poorly. This tactic works even better for the period before January 2013 where there is no public data about PMS performance. See PMS investment is too risky, opt only if you have a large portfolio
Similarly, companies point to the good ratings of their debentures / NCDs or Structured Products. But companies often hire the rating agency that is hungrier for business and is willing to provide a better rating. See Seven questions that private equity investors ask when making investments
Conclusion
Whether or not you know it, you are fighting a battle for 1% of your net worth each year. Once you learn to spot this battle, you will start noticing it everywhere — for example, the ridicule and hostility that Dalal Street directs towards low-cost index funds. See ‘Step 8 here: This will change the way you invest: S&P Index Versus Active Funds report. Or your investment adviser recommending a complex portfolio of mutual funds and/or stocks so that you have to continue to engage with them. See: Three simple tips to choose the right financial advisor
The outcome of this battle will determine whether Dalal Street can feed their family, or whether you will be able to feed yourself and your spouse during retirement. It is a life or death battle for both sides. As a first step to defending against this, follow the mature approach to personal finance — diversify and minimize investment costs; plan for zero real-returns; stop chasing alpha and instead focus your attention on the big-picture questions including asset allocation, and minimize mistakes (relevant article as an audio presentation
Also as and as an article: Are you ready for a mature approach to personal finance.
Avinash Luthria is Founder, Fee-Only Financial Planner & SEBI Registered Investment Adviser (RIA) at Fiduciaries; He was previously a Private Equity & Venture Capital investor for 12 years and has a flagship-course MBA in Finance from IIM Bangalore; He writes about Financial Planning & Investing in Business Standard, Mint, MoneyControl, The Ken, VCCircle etc. See full list of articles. Views expressed here are of the author and do not necessarily reflect the views of FreeFinCal
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