Why some financial products are today’s overhyped “miracle cures”

calculator gamble

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “While new financial products flooding the market may offer some benefits, it pays to remember that the incentives are heavily weighted in favour of the seller, not the buyer.”

Today’s financial industry is a little like the 19th century pharmaceutical industry.

In the 19th century, scientists and hucksters were free to come up with new products, and make any marketing claims they wished. Buyers found it hard if not impossible to tell the difference between effective or ineffective treatments. Besides, they were anxious about their own health and the health of their loved ones. They wanted to believe what they heard.

Pharmaceutical innovators were not necessarily bad people. They too wanted to believe their own claims. Some may have felt they were selling peace of mind, in the form of a harmless placebo. As scientific knowledge advanced, however, it became clear that not all treatments worked. Worse, some ineffective treatments were far from harmless.

In the past few decades, barriers have fallen among the brokerage, underwriting, insurance and banking industries. More and more new financial products have come along as a result. All are combinations and permutations of the three basic financial products: equity investment, fixed-return investment and insurance. Every one of them brings fees to the sponsoring institution and salesperson. Many also generate a continuing flow of fees.

The initial and subsequent fees create a tsunami of financial incentives for everybody involved in the business. These incentives could taint the judgment of a saint, let alone an ordinary human being.


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The closer you look at the fine print, the more risks you spot

Mostly, the worst these products do is drain away a little of your capital. In return, they may reduce the volatility of your portfolio, or at least give you a feeling of security. However, we can now look back and see how the financial innovations of recent decades helped bring on the housing price collapse in the U.S., as well as lesser but still critical financial crises in Canada.

In the course of providing investment advice, I sometimes single out and write about a financial innovation that I see as a particularly bad deal for investors (I’ve written a good deal recently about the hidden costs of index-linked GICs, for instance). I’ll explain its drawbacks as diplomatically as I can. But I still get vitriolic letters of complaint about these analyses. They mostly come from salespeople who may have lost a sale or a client because of the article.

The bitterness of these letters is understandable. When you sell intangibles such as financial innovations for a living, you have to commit to them. You have to dismiss any and all doubts about the product. Otherwise, you’ll never make a sale. When some outsider comes along and criticizes the product, it’s natural to want to shoot the messenger.

Sometimes, though, I’ll also get letters from retired brokerage, banking or insurance employees. They write that they are dismayed at the low quality and/or investor-abuse potential they see in some new products their former employers are selling.

But it’s not as if struggling investment salespeople have a monopoly on outraged letter-writing. I get equally outraged letters, for instance, when I write that a number of President Obama’s policies have not been good for investors or business.

I will continue to remind readers of these financial products now because the financial industry continues to promote them. These products may seem like a great deal at first glance, or based on a 30-second verbal description. But the closer you look at the fine print, the more likely you are to spot the risks.

For that matter, the more fine print there is, the more likely it is that you should avoid the product. After all, risks and disclaimers go in the fine print. The advantages are spelled out in big letters.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Have you bought highly publicized financial products that failed to live up to the hype? Have you ever bought any of these products whose returns more or less matched or even exceeded the promises made?

Note: This article was originally published on September 13, 2012.

Comments

  • Thanks Pat, a great article and it helps to keep me on an even keel. When it sounds too good to be true, due diligence applies.

  • I agree with your assessment of index-linked GICs. In 2000 my wife purchased a 5 year index-linked GIC. In 2004 she was given her guaranteed money back and told that it had actually had a value less than she paid for it. She then invested it in a self-directed RRSP and by 2008 had doubled the value. I realize timing was involved but our other investments went up in the initial 5 year period.

  • Dear pat, I had an advisor from a major securities firm in the late 90’s .this man steered me into tech mutual funds ,say no more ! . I said to myself he is not working for me, so its time to get smart .
    . I used to receive the ‘money letter’ and had read articles written by you , which impressed me for your plain basic common sense on investments . When I came across the ‘Successful Investor’ I signed up , it has taught me a lot and keeps doing so , that goes back about 10 years . Thanks again …..Ted Anstice

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