There are no bad financial products. Only products that are used wrongly. When you try to force fit a product or financial service to fulfil a need it was not intended for, it is likely to fail. It is important to understand the features and suitability of a product and map it to your needs and preferences to get the best out of it. Here are some common product misuses that you need to watch out for.
Duration of product vs need
When your efforts to save for long-term goals, such as the children’s education and retirement, do not seem to be making much headway, it is a cue to check how the funds are being held. If the savings earmarked for long-term needs are held in products such as savings bank accounts, short-term debt funds and other low-earning products designed to provide liquidity rather than capital appreciation, then the growth in the corpus is likely to be negligible. The lower rate of returns also means that the benefit of compounding is also lower.
If it is inertia that keeps you from investing in products designed for capital appreciation then sign up for automated facilities offered by mutual funds, banks and even insurers to periodically move funds into investments of your choice. You could use the services of a financial planner as well to help you make these decisions.
If it is the fear of losing value that makes you leave money in ‘safe’ products, then you must understand that lower returns will mean a much smaller corpus at maturity. A better option would be to understand the risks in the products available to invest for long-term goals and select those that are best suited to your needs.
When you find yourself either cutting back on goals or resorting to debt despite having saved and invested for them, it again indicates that the money may be in the wrong products. A fall in the equity markets may mean that you have to sell investments at a loss to fund that holiday you have been saving for. The fault does not lie with the equity investment. It lies in the fact that you invested money that you may require in the immediate future in products like equity which see short-term volatility.
Similarly, using real estate investments to accumulate a corpus for the short term may not be an effective strategy. Even if it is for the long term, you should liquidate the investment and move the funds to liquid, short-term investments well in time to meet the goals. But beware that real estate is not easy to liquidate.
The harm in fixed returns
Fixed and guaranteed return products may be suitable for the distribution stage when your goals are at hand and you need regular income, such as cash flows to meet college fees or income in retirement. However, the assured returns in such products comes at the cost of lower returns. This makes them less suitable for longer-term goals in the accumulation stage as lower earnings translate into lower corpus. You may have to increase your contribution to the goal to make up for the lower earnings. And since savings are more often than not limited, it means that you may have to pare down your goals to fit into the corpus available. This can be avoided if you choose a product better suited for the accumulation stage of goals.
When you use traditional insurance policies as a means to accumulate a corpus for the future, you are condemning your goals to the risk of failing. The primary purpose of insurance is to provide protection. When you try to use it as an investment product, you are settling for lower returns, high charges and inflexibility since they are not designed as an investment product.
Other incorrect use of products include using credit cards as a source of income and as an emergency fund, when it is just intended to be a product to help you manage expenses out of available income. Using it incorrectly leads to high debt, and diverts money away from other goals.
Mixing tax planning and investment needs is another combination that can go wrong. Tax-saving products are often debt-oriented, and adding them merely for tax benefits may increase the proportion of debt in the portfolio beyond what is suitable. Also, the lock-in that these products typically have restricts your ability to use these in case of an emergency.
When markets dictate choices
If you are inclined to move in and out of investment products depending upon how markets are expected to perform, then it is likely that your portfolio is not aligned to your goals. You may be tying up your funds into equity, debt, gold, real estate and other asset classes without considering your need for growth, income or liquidity. Tactical portfolios like these require skill, information and time to make alterations based on expected market movements. It also implies taxes and costs that can affect returns.
Identify products that are structured to meet your needs rather. A wrong product or service choice may tie you into a financial commitment that does not add value. Make it a habit to argue the pros and cons of each money decision and evaluate the financial consequence.
First Published: Mon, Sep 18 2017. 03 18 AM IST