Mis-selling and mis-buying: both need to be curbed

The purchase or sale of financial investment products is a delicate affair. It is not merely about preferences as in the case of buying a consumer product like a car or shirt or even getting a haircut, it is about suitability— whether it can meet the requirements and objectives of an investor. If the investment product is not suitable, or if any investing is done without proper understanding, the outcome could be unpleasant. Surprisingly, people spend more time on due diligence where it concerns consumer products but not so when it comes to financial investments.

When people invest in a product that may not meet their requirements, the distributor is held responsible for mis-selling. However, investors should note that they too have a responsibility. To avoid instances of mis-selling, it is better to take professional advice from a financial planner or registered adviser. And if you are one of those investors who prefer do-it-yourself (DIY), do note that you will need to have set parameters and priorities in place.

First, it is not a matter of choice, as in selecting a flavour of ice cream. It is an objective decision that is made after considering aspects such as the duration of your investment, your risk appetite, and whether you are comfortable making that investment with your hard-earned money. Yet, the foremost thing people want to gauge is the return on their investment. However, that should not be the principal basis on which anybody should make their investments. Higher the risk, higher is the return expectation. Yet, you have to draw the line somewhere and ask yourself how much risk you are willing to stomach. There are conventional investments like equity, bonds, gold, etc. There are regulated investment vehicles like mutual funds, alternative investment funds, portfolio management services. There are relatively new and emerging investment avenues that are regulated, for e.g. peer-to-peer lending, and bill discounting through exchanges. Then, there are risky and unregulated ones like cryptocurrency. Even if something is regulated, you need to have proper understanding of the risks associated with that product.

A Sebi circular dated 19 May states that when individual traders log into their trading accounts with stock brokers, a risk disclosure should prop up. The message should cover at least 50% area of the screen. The risk disclosure is about derivatives. It informs that 9 out of 10 individual traders in equity futures and options segment incurred net losses. Over and above the net trading losses incurred, loss makers expended an additional 28% of net trading losses as transaction costs. Those making net trading profits incurred between 15% and 50% of such profits as transaction costs. Nobody willingly takes trading positions to incur losses. But the data reveals that the mere intention to earn profits does not lead to profits. It requires expertise, experience, ability to handle any losses and make a recovery thereafter.

Undergoing an online course on equity derivatives imparts the basics, but it does not automatically lead to profits. Do note that equity derivatives are a vibrant, liquid segment of our markets that contributes to price discovery. The question here is whether it is suitable for you and whether you want to get into it.

The Securities and Exchange Board of India (Sebi) has checks and balances in place to curb mis-selling. Registered investment advisers (RIAs) have to maintain detailed records of client risk profiling and why the recommended products are suitable for the client. Mutual fund distributors cannot charge fees and cannot advise clients like RIAs, but are expected to do basic risk profiling of client. Separately, guidelines on ‘finfluencers’, or financial social media influencers, are being discussed, and are expected to be unveiled in some time. However, regulation can do only so much. Buyers also have to be conscious of their decisions . The principle of ‘caveat emptor’ in law states that the buyer alone is responsible for checking the quality and suitability of goods before a purchase is made. If you are into DIY, you alone are responsible for the stocks or direct plans of mutual funds that you buy.

If you are taking professional guidance, you have to ask the right questions to your financial advisor. Rather than asking ‘kitna dega’ (how much returns will it fetch), you have to question the logic for the recommendations. When I go to the doctor, I do not do a Google search on the medicines that are prescribed. For, I am taking expert guidance. But I do ask what is it that I am suffering from or what the medicines are for.

Joydeep Sen is a corporate trainer and author.