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The easy alternative to financial literacy

Conservative savers' interests are best served by limiting themselves to a very short list of investments and ignoring everything else.

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In recent weeks, there has been a spate of news articles about people who have invested in 'private debt placement,' and have lost all or most of their money. As one would expect, the news articles contain claims from savers that the agents who sold them this 'private debt' made promises of high returns and perfect safety, while the agents claim that the investors were made aware of the risks beforehand and that the paperwork makes it clear that the debt was not secured and that there were no guarantees. Some of these agents are private wealth management businesses of well-known financial brands including some banks.

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I'm sure that the intermediaries have protected themselves adequately from a legal standpoint. After all, keeping oneself legally protected while selling dubious products is a core competence of the financial industry - in a sense that is what the business actually is. Clearly these people are smarter than the teak-plantation-emu-farming proponents as well the Saradhas of the country.

From what I've seen and heard, it's clear that the typical customer in such transactions is quite unequipped to evaluate the risk level of the deal that they are getting into. In some cases, interest rates of 20 per cent per annum were promised. If anyone believes that an interest rate of 20 per cent will be paid for a deposit, and the principle and interest will be paid back as expected, then this itself disqualify one from investing. Conventionally, in most such discussions about scams, the solution that is offered is financial education because the problem is identified as a lack of financial literacy.

Based on my observation, those selling such products actively seek out the financially illiterate. Some years ago, Microsoft Research published a paper titled 'Why do Nigerian Scammers Say They are from Nigeria?' The answer to the question is obvious. If you send a scam email which sounds too ludicrous to be believed by any but the most gullible, then those who respond to you will by definition be really, really gullible people. The implausibility of the claim will itself act as a filter. Similarly, if you are selling a debt product that promises 20% a year with 100% safety, then you can be certain that only the completely financially non-literate will be interested, making your task easier.

Perhaps my argument has painted me into a corner because this is beginning to look like a circular problem. It's easy to see why: basically, people who are not financially literate do not know that they are not financially literate. If 20% looks like a reasonable return to you, especially in a story narrated by an expert salesperson, then that's it. You have no way of knowing that it's a highly unlikely interest rate.

One possible way that such a decision can be made is to not have to make a decision. That makes the financial literacy task much easier. It's difficult to formulate a set of rules that try to define what would be an avoidable investment and then hope that everyone can understand and implement such rules. That leaves the field open to a whole world of artful companies and salespeople to invent newer ways of separating people from their money.

What does a list of acceptable investments look like? Such a list should basically consist of the PPF and other sovereign deposits and bank FDs for those who want absolute safety at the cost of some returns and tax efficiency. I would also say liquid funds but this list is for those who are not confident of their financial knowledge.

To such a safety-first portfolio, high returns are better added with 20-30 % of hybrid mutual funds rather than adding risk with dodgy debt products. The problem with suspect debt products is that they offer somewhat higher returns, but if they don't work, then typically, the entire principal is lost. That's the worst of all worlds. Instead, it's better for a conservative investor to aim for absolute safety with 60-80 per cent of their savings and then add a well-regulated product like equity or hybrid mutual funds for extra returns.

In principle, instead of people trying to apply rules and recognise the negatives, it's better to have a short list of positives, i.e., savings and investment vehicles that are acceptable and ignore everything else. It's hard luck for those who are trying to sell anything else, but better to have hard luck for them than for savers.

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