FINANCIAL products do not necessarily need to be complicated. A credit card or savings account and car or travel insurance are relatively straightforward products.
But don’t be fooled, even a simple product such as a personal loan has caveats which can hurt you. Ever heard of the “Rule of 78”.
Rule of 78 is a financing method that allocates pre-calculated interest charges that favour the lender over the borrower on short-term loans, according to www.debt.org
As financial literacy in a country rises, the complexity of financial products grows with it.
Why? A benevolent explanation would be that people are able to understand more complicated financial products, which better fit their needs.
Personally, I think that the complexity of financial products grows in order to continually sell people unbeneficial products which they can’t fully understand.
Most financial products people need are commodities, with little differentiating power between different companies.
This means they are selected mostly on price, which is great for you, but kills the profit margin for the industry.
At times, those who package the financial products make it so complex to a degree that most people won’t understand how they work.
Hence it may make it easier to hide substantial commissions, fees and other costs.
Complexity always favours the seller, not the buyer.
Perhaps, one way to complicate a financial product is to combine it with another, for instance investment-linked life insurance products.
First, if you invest through an insurance company, you are paying two intermediaries: the agent who sells the product takes a commission and then the insurance company also charges you a fee for investing on your behalf.
An amount equal to, or more than, the first year of premiums is typically given to the insurance agent as commission.
Sometimes, the range of investments which the insurance company offers you could be limited and costly. This is in contrast to the wide range of low-cost mutual and index funds available in the open market.
Secondly, by tying insurance and investments together, you lose the flexibility to make adjustments in one, without changing the other, for example, because your personal situation changes.
Do check that if you want to opt out, sometimes the penalties and fees are typically high, and any stock market returns you have made on paper disappear.
Thirdly, you should monitor the investments managed by the insurance company and check their track record.
There is some concern that the funds are guaranteed to have money flowing in from the policy holders, who can’t easily take their money out. Hence there is concern that this could shield the underperforming fund managers from the competition.
Fourth, the worse a product is, the higher the commission the company must offer its agents to sell it, the harder they will push it and the more damage it will do to your finances if you buy into it.
Why do people buy combined insurance and investment products?
Because they are not financially sophisticated enough, because of the belief their insurance agent can also be their investment advisor, because it is sold as having unique (tax) benefits that are otherwise unavailable, and because people underestimate the value of liquidity.
You insure to protect your assets from forces outside your control while you invest to grow your assets.
I would prefer that you buy separate life insurance and investment products as close to the source (the assets themselves) as possible.
To get a better deal, buy online or hire a certified financial planner whom you pay an hourly fee instead to make sure your interest align more closely.
Mark Reijman is co-founder and managing director of https://www.comparehero.my/ dedicated to increasing financial literacy and to help you save time and money by comparing all credit cards, personal loans and broadband plans in Malaysia.