Opinion
Which financial products should you be wary of?
Summary
- For most people, diversified equity funds, PF, and NPS are enough for the long term
The financial landscape is full of products jostling to grab your attention (and of course, money). And while each product has its own set of target population, the problem arises when the wrong (or rather unsuitable) product lands in the hands of investors. The result? Undesired investment outcomes. It is therefore very important to understand which products are best avoided. More so for small investors who have limited capital and, hence, pay a proportionately bigger price if they get into unsuitable products. So, let’s have a look at a few products which are best avoided.
Endowment & unit-linked insurance plans (Ulips): These traditional life insurance plans neither provide sufficient life cover nor provide good investment returns (you get 5-6% maximum). You are better off without them. Like traditional insurances, Ulips also hybrid products offering both insurance and investment. But since there is an option to invest in equities via Ulips, they give potentially better returns than endowment or moneyback plans. But for most, Ulips are best avoided as first, they don’t give good life cover for the premium charged; secondly, actual investor-level returns get subdued due to different deducted made via unit cancellations.
Thematic and sector funds: Every now and then, there is a sector or thematic fund that ends up topping the returns chart. This attracts the attention of many who rely (solely) on past returns to pick funds. But given the cyclical nature of each industry or sector, the chances of sectoral bets doing well one year after the other are low. So, while some sectors will do very well and give market-beating returns in the short term, chances are they will fall flat over the next year due to cyclicity. So, small investors should at best avoid investing in risky sectoral funds as there is no perfect way to predict which sector will do best the next year or the year after.
Small-cap funds: Due to their inherent nature, smaller companies pose higher investment risks. And this holds true for smallcap funds that invest in such companies. While these funds generate impressive returns on certain occasions, they are also prone to periods of low-to-no returns during economic downturns, which affect smaller companies much more than larger ones. So, the resulting fluctuations in returns are what makes these funds unsuitable for many, even though the long-term CAGR profile for many small-cap funds may make them seem sure-shot bets. The CAGR figures hide the emotional upheaval that an investor goes through in such funds.
Given the inability of active large-cap funds to consistently beat passive large-cap indices like Nifty50, there is merit in just investing in passive funds for large-cap exposure instead of active funds. So, even active large-cap funds can be avoided to keep the portfolio simple.
PMS: Porfolio management services (PMS) have a minimum ₹50 lakh requirement and hence, it is out of most small investor’s reach. But even if one has ₹50 lakh to spare(!), it is best to avoid PMS. Most PMS are high-risk-high-return kind of products which target high returns by taking concentrated bets. Also, the fees (fixed and performance-linked) are not very investor-friendly. This product is best suited for larger investors who have sufficient surplus to take small risky bets via the PMS route.
Unlisted shares: This is a highly risky and illiquid space. There is no transparency in the unlisted space with no guarantees that the shares will ever list or generate good returns.
This list isn’t exhaustive by any means. But as an investor, I can tell you that you need to say ‘No’ more often than ‘Yes’ when you are looking to invest in some new product. Just a few reliable instruments like term life insurance, family floater health insurance, bank fixed deposits (or a few debt funds) for short-term and diversified equity funds, provident fund, national pension scheme, etc., for long-term are enough for most people.
Dev Ashish is a registered investment adviser and founder of Stable Investor.
